Idea
The past decade made investing look easy – 13% returns per year from the S&P 500, no questions asked. But the next ten years are shaping up to be a whole different story, and if you’re betting on another blockbuster decade, you might be in for a nasty – and costly – surprise. See, even if you make some pretty optimistic assumptions, US stocks are likely to return a mere 5% per year. What’s worse, the risks are tilted to the downside. So this is a good time for a gut check. Let me break down how things have changed now and what it means for your portfolio.
Thesis
Three big forces drive long-term stock returns: dividends, earnings growth, and changes in valuations.
Ten-year returns have swung wildly throughout history – from a very satisfying 15% per year to outright losses, rarely landing anywhere near their long-term 10% average.
The best returns happen when expectations are low – like after a recession. Cheap valuations, pessimistic sentiment, and a low bar for earnings growth set the stage for a big upside surprise, as both profits and valuations expand.
The worst returns happen – you guessed it – when investors are too hopeful. When they ignore the risks and expect the gravy train to continue on forever, disappointment is almost inevitable.
So the starting point matters when investing – and today’s isn’t great. High valuations and record profit margins don’t just suggest below-average returns – they tilt the odds toward downside risk.
After making reasonable assumptions and stress-testing the numbers, I found three likely scenarios:
Scenario 1: The base case (50% probability, 4%-7% returns). Stocks would see steady sales growth, modest margin expansion, and a slight valuation dip – not a disaster, but still well below the past decade’s gains.
Scenario 2: The downside case (30% probability, near 0% returns). Margins would shrink and valuations would fall closer to historical norms, dragging returns to flat over the decade.
Scenario 3: The upside case (15% probability, roughly 10% returns). AI would drive major productivity gains and valuations would hit new highs – but it’d take near-perfect conditions to pull this off.
Key risks
Forecasts are only as good as the assumptions behind them – the future does love to surprise us. While we can make reasonable guesses based on today’s data, plenty of “known unknowns” (like runaway inflation) and “unknown unknowns” (think: AI emerging and rewriting the rules of the game) could push returns in totally unexpected directions.
The scenarios presented here are my best estimates using a structured process, but the real outcomes could be something else entirely – and that’s worth keeping in mind.
Part 1: What drives ten-year returns?
Three things move the needle for stocks over a decade: dividends (adding a steady trickle), earnings growth (fueled by sales, margins, and buybacks), and valuations (the big swing factor). US stock returns have a long-term average of 10%, but here’s the catch – they don’t cruise along at that level at every ten-year interval. Instead, they’re either stellar, disappointing, or downright ugly. And the biggest clue as to what you’ll get? Your starting point. When valuations are low, expectations are in the gutter, and earnings have room to rise (like at the tail end of a recession or inflation squeeze) that’s when returns tend to shine. But when investors get excited, ignore risks, and bet that the good times will roll on forever, it can be a different story altogether.
Stocks can be unpredictable in the short term, but the longer you hold them, the more likely you are to come out ahead. That’s because stocks offer a “risk premium” – essentially a reward for taking on investment risk – which has historically been about 6% per year in the US after inflation (note that the premium isn’t as high in most other regions and academics say it shouldn’t be quite so high in the US, so keep in mind that it could fall in the future).
The longer the time horizon, the more US stock returns fall in line with their long-term average. Sources: Credit Suisse, Finimize.
Issue is, if you want to be confident that you’ll earn that long-term “expected” return, you’ll need to hold stocks for a very long time – think 70 years or more. Certainly longer than ten years anyway: over a decade, returns vary wildly from their average (from -5% per year in real terms to +15%). And potentially much longer than a decade: even over 50 years, investors in Japanese stocks made a loss (after adjusting for inflation). Holding stocks for the very long term is the safest thing to do, but the truth is, most of us don’t have that kind of time.
Ten years, then, hits a sweet spot: it’s long enough to smooth out the noise (daily market drama, say, or short-term economic shocks) but short enough to nudge you closer to your goals. And since returns vary wildly over that horizon, there could be strong gains from putting the odds in your favor. A little further down, I’ll show you a way that you might do that.
Ten-year returns swing wildly around their long-term 10% average, with periods of below-average returns following periods of above-average returns. Source: Finimize.
Over that sweet ten-year horizon, three big factors will drive total stock returns:
Total S&P 500 return = growth in earnings per share (EPS) + changes in valuation + dividend yield
But, because there are compounding effects and some interplay between these variables, the exact mathematical formula is:
Total S&P 500 return = -1
When you’re investing in stocks, three things can put money in your pocket: your company might pay a dividend, it might grow its profits, or investors might be willing to pay a higher price for those profits (i.e. its valuation multiple might expand).
Let’s look at each possible driver.
Driver #1: Dividend yield – a.k.a. your “income”
Dividends are like a stock’s version of a bond coupon: they’re the income companies pay to shareholders, expressed as a percentage of the stock price. It’s money you can typically count on, even if the stock price doesn’t budge.
Historically, dividends (when reinvested) have been a steady contributor to returns. Back in the early 1900s, in fact, dividend yields contributed north of 5%. But these days, they’re generally south of 2% – partly because companies these days tend to use buybacks as a way to return money to investors. While dividends can give your returns a reliable jump start and contribute strongly to your total returns over multi-decade horizons, they’re not the driving force behind the big swings in ten-year returns.
Dividends compound nicely over time and can give you a nice lift, but they aren’t the driving force behind the big swings in 10-year returns.
Driver #2: Growth in earnings per share – a.k.a. your split of the profits
Earnings per share (EPS) reflect how much profit each share represents. When it grows, it’s a win-win: bigger profits mean higher potential dividends and a higher stock price (you’d be willing to pay twice as much for a business that earns $2 as one that earns $4, all things being equal).
EPS growth has three components:
Sales boost. Companies make more money when the economy grows, when they gain market share, or when inflation boosts prices.
Margins widen. Higher profitability comes from cutting costs, improving productivity, or raising prices – though margins can also shrink when competition intensifies.
Share buybacks. When companies buy back their shares, EPS grows because profits are divided among fewer shares. Like dividends, share buybacks are a way of returning money to shareholders.
The formula is:
EPS growth = - 1
And if you want to break down further with your legendary math skills:
EPS growth = - 1
Historically, the S&P 500’s earnings growth has averaged around 5% per year over ten-year periods since 1900. And that makes sense: the economy has grown and this index tracks some of its most successful companies. Half the time, earnings growth has landed between 2.9% and 7.9%, giving investors a solid foundation for returns. When you add the dividend yield to that earnings growth, you can see why returns are positive most of the time over ten years.
But earnings growth isn’t always smooth – it’s tied closely to the ups and downs of the business cycle. In boom times, earnings have surged by as much as 15% a year, but in bust times – like the Great Depression or the Global Financial Crisis – earnings have shrunk by up to 15% annually, over a full decade.
Earnings growth (shaded blue) has come out positive most of the time, but it has been negative too – even across a decade. And the impact of that on the S&P 500’s total returns (dark blue line) is clear. Source: Finimize.
Driver #3: Changes in valuations – a.k.a. your secret “leverage” factor
Even if profits don’t grow and dividends dry up, you could still make money – as long as other investors are willing to pay more for the same profits. Now you might be asking yourself why they’d do that. Well, the answer comes down to a mix of rational fundamentals and emotional sentiment.
The rational, fundamental side:
Profit margins and growth. If investors expect faster future earnings growth – maybe from some game-changing technology – they may be happy to pay a premium now, betting that profits will eventually catch up.
Interest rates. Lower borrowing rates make future earnings more valuable today, pushing valuations higher. It’s math, not magic.
Inflation. Price stability keeps valuations healthy. But extremes – like deflation or hyperinflation – will spook investors, making them demand higher returns (and pay lower valuations) as compensation for those risks.
Supply and demand. Sometimes, there just aren’t enough high-quality companies in certain sectors to go around. More demand equals higher prices for those profits.
The emotional side:
Valuations are influenced by fundamentals but filtered through the lens of investor psychology. When greed takes over, risks are overlooked, and valuations can shoot up as investors pile in. Behavioral tendencies like FOMO, recency bias, and confirmation bias can turbocharge this effect, pushing prices well beyond what’s reasonable (up or down).
Economic cycles set valuations in motion, and investor sentiment accelerates the move. The result is that valuations rarely sit at equilibrium – they swing like a pendulum from extreme highs to extreme lows.
You can see this in the data. Over the past 125 years, changes in valuations have added just 0.5% per year on average to total returns. Unlike earnings growth or dividends, you can’t count on valuations to adjust your returns over the long run.
But here’s what I find really interesting: while their ups and downs tend to cancel each other out over the long term, they are hugely influential over ten-year periods – in fact, they’re arguably the biggest driver of your returns.
So invest when valuations are rising from a low base, and they’ll supercharge your returns alongside earnings growth and dividends. Invest when valuations are falling, and they’ll drag down your returns – sometimes enough to turn positive earnings and dividends into negative total returns.
Periods of multiples expansion follow periods of multiples contraction (blue). And the S&P 500 (black) tends to rise and fall with changes in those stock valuations. Source: Finimize.
Let’s look at how all three factors played into ten-year returns over all those years.
Here’s a breakdown of ten-year returns into earnings growth (blue), changes in valuations (yellow), and dividend yields (light blue). Source: Finimize.
As you can see, earnings growth and dividends are usually positive and give your returns a solid foundation. However, because valuations swing between extremes, ten-year returns are rarely “average”. Instead, they tend to land in one of three categories: stellar, below average, or downright ugly.
The vertical axis shows the number of ten-year periods that landed within a specific stock return bracket (horizontal axis). As you can see, below and above-average came along more often than average returns – and there have been more than a few instances of ugly returns. Source: Finimize.
This isn’t just a cool chart: if you can figure out what drives stellar, disappointing, or ugly returns, you can tilt the odds in your favor.
Historically, it’s been surprisingly straightforward: when starting valuations were low (relative to their historical levels at the time), they had room to grow, which often led to higher returns. On the flip side, when valuations were high, there was less room for expansion and more risk of a drop if economic conditions or sentiment went sour.
Low starting valuations (blue line) have tended to lead to high subsequent returns (black line) with multiples having room to expand. Source: Finimize.
Of course, earnings also play an important role, but unlike with valuations, there’s no clear-cut link between where they start and how much they grow.
Part 2: How has this played out before?
Let’s take a look back at some concrete examples to make sense of this. We’ll do this by checking out key years in market history and highlighting what happened in the ten years that followed. (So in the case of 1919, we’d be looking at the ten years leading to 1929.)
Quick heads-up: for stock valuations here, I’ll be using the cyclically adjusted price-to-earnings (CAPE) ratio. It’s the go-to metric for most investors because it averages inflation-adjusted earnings over ten years, smoothing out the ups and downs caused by economic cycles.
1919: The roaring twenties (+19% yearly returns)
After World War I, valuations (the CAPE) plunged from 24x to 4.7x in 1920. With both earnings and valuations starting at seemingly rock-bottom levels, there was only one way to go: up. The economic boom of the 1920s meant earnings soared, and since investors didn’t price in the chance of that happening, multiples jumped. By the end of 1929, ten-year annualized returns had hit a roaring 19%.
1929: The Great Depression (-4% yearly returns)
Now those Roaring Twenties fueled investor euphoria, pumping valuations up to 31.5x by 1929. People just expected the good times to keep on rolling. Folks thought nothing could wrong but, boy, did it: a historic stock market crash and banking crisis wrecked the economy and investor confidence. The -4% annualized returns over the subsequent decade illustrate the dual impact of collapsing earnings and investor sentiment.
1940 to 1958: Midcentury and the post-war boom (consistently above 10% a year with a high of +21% in 1949)
Dirt-cheap valuations (with CAPE between 5x and 10x after the Great Depression) and overwhelming pessimism during World War II created a scenario where improvements could trigger some rapturous upside. And they did: the post-war economy boomed, fueled by surging consumer demand, suburbanization, and huge government stimulus measures. Optimism caught up, pushing valuations above 20x by the end of the period – leading to major changes in valuations given the low starting point. Earnings growth was consistent and strong, averaging 10% annually throughout the 1950s. This combination of low starting valuations and strong earnings growth led to cushy returns above 10% annually for nearly two decades, peaking at 21% for those who invested in 1949.
1964: Inflation’s bite (+1% returns)
The optimism of the post-war boom carried into the 1960s, but high starting valuations (CAPE at 23x) and record profit margins in relation to the size of the economy left little room for improvement. Inflation surged through the 1970s, hammering valuations (which would crater to 6.6x by 1974) and squeezing margins. So even though earnings grew on a nominal basis (meaning: not adjusted for inflation), investors saw a disappointing 1% annualized return over the period.
1977 to 1991: The valuation supercycle (consistently around +15%)
The end of the 1970s era “stagflation” – a rare and dreaded combination of high inflation and slow growth – set the stage for a golden era in stocks. With CAPE at just 6.6x, valuations had plenty of room to run. Margins grew steadily from low levels, but the big driver was the massive recovery in multiples, which soared to 43.5x at the peak of the tech bubble in 2000. Starting from such a low base propelled annualized returns to double digits again and again, averaging about 15% for over two decades.
1999: Reality check (-4%)
Hype about the World Wide Web’s coming tech revolution drove stock valuations to record highs in 2000, sending the CAPE ratio soaring to 43.5x. Investors were pricing in perfection, but reality had other plans. Valuations tanked when investors realized their expectations were way too optimistic, and the Global Financial Crisis delivered a major blow to earnings eight years later. The back-to-back traumas sent valuations and profits plummeting, resulting in a painful -4% annualized return over the following decade.
From 2011 to 2014: Recovery and growth (consistently topping 10%, with a high of 16%)
The Global Financial Crisis left valuations, margins, and sales per share at deeply depressed levels, setting a low bar for improvement. Central bank stimulus, globalization, deregulation, and the rise of US tech (growing from 20% to 40% of the S&P 500’s weight) boosted both earnings and valuations. Returns consistently exceeded 10% annually, peaking at 16% for the 2011–2021 period. Even corrections during the Covid-19 crisis in 2020 and the inflation spike in 2022 couldn’t derail the broader trend, as low interest rates, big stimulus measures, and new technological opportunities pushed valuations and earnings to new highs.
The key takeaway from looking at history is clear: the best returns tend to follow periods of low valuations, depressed expectations, and a low bar for earnings to grow – say, after a recession or when inflation has temporarily squeezed margins. When pessimism reigns and the business environment delivers, returns soar – boosted by both expanding multiples and strong earnings growth. But when investors are euphoric, ignore risks, and project past success into the future, returns often disappoint. When it comes to forecasting ten-year returns, the starting point matters.
Now let’s see how to use this to your advantage.
Part 3: What will the S&P 500 return over the next decade?
Stocks are starting from a tough position, with high valuations and record profit margins seeming to set investors up for disappointment.
Good forecasts mix two perspectives: the “outside view” (what historical data suggests) and the “inside view” (the unique factors that might make the future look different from the past).
The outside view paints a challenging picture. With valuations and profit margins at record highs and sales per share having rocketed over the past few years, even hitting “average” levels on future returns is a big ask. Historically, when starting points look like today’s, the odds are stacked against strong returns over the next decade.
But the present is never a carbon copy of the past, so let’s check out those key drivers from Part 1 to get a realistic sense of what’s ahead.
Driver #1: Dividend yield forecast
You can expect dividends to add somewhere between 1% and 2% to returns each year. That’s a small but steady contribution.
Driver #2: Earnings growth forecast
Expect earnings growth to contribute 4% to 6% per year to returns, with risks on both sides.
Breaking it down further, expect a roughly 4% contribution from growth in sales per share. That’s slightly below the 5% we saw over the past decade but right in line with its average since 1990. This isn’t a bearish forecast: it assumes the US economy will grow at a healthy 3% to 4% pace and that American companies will continue capturing a bigger slice of global trade.
Of course, there are risks to this assumption. Overseas competitors have been catching up, deglobalization trends could limit market share gains, and a potential economic recession or credit crunch in the next decade could slow sales further. On the flip side, stronger-than-expected growth is possible if tech breakthroughs materialize. But, for now, 4% sales growth seems like a reasonable, “neutral” starting point.
Trailing 12-month sales per share (black) has trended upward since the early 1990s. But the pace of the measure’s changes, measured in changes to trailing 12-month sales per share (blue) doesn’t usually stay this high for long. Expecting 4% growth in sales per share is arguably a reasonable “neutral” starting point. Source: Finimize.
Expect profit margins to expand up to 15.6% (from 12.7% today), contributing 0% to 2% per year. And, yes, that means profit margins would remain near record levels, and that further expansion would likely be limited.
Historically, margins (and adjusted corporate profits as a share of the economy) have tended to mean-revert, meaning they tend to snap back to their usual – or mean – levels. But since the 1990s, they’ve climbed steadily in the US, adding around 3% a year to returns.
US margins (represented by adjusted corporate profits over economic growth) broke above their long-term range in the 1990s. Sources: Federal Reserve Economic Data (FRED), US Bureau of Economic Analysis.
And that’s stunning, but here’s the real jaw-dropper: research by Federal Reserve economist Michael Smolyansky found that over 40% of that profit growth since 1990 came from just two factors: falling tax rates and interest rates. Add to that the boost from global labor cost wheeling and dealing ever since China joined the WTO in 2001, the US tech sector’s gradual dominance in indexes, and you get a perfect storm – one that’s very tricky to repeat. Margins in other developed markets, for example, have stagnated for two decades.
A huge fall in tax and interest costs left more money for shareholders. Sources: Compustat, Michael Smolyansky.
And several factors could squeeze margins for US firms over the next decade.
Stiffer competition. High margins rarely stick around, even for the best companies. New entrants, innovation, and regulation tend to chip away at advantages, and very few firms manage to sustain extreme margins for more than a few years.
Concentration risks. Today’s record-high margins are clustered in a handful of dominant companies, leaving them more exposed to disruption and competition. And these days, disruptive forces can upend things faster than ever (just look at the market chaos brought by the news of DeepSeek’s cheaper, more efficient AI models).
A potential profit share peak. Political pressure to address inequality, along with rising costs from re-shoring and geopolitical tensions, may well shift a bigger share of economic output back to workers and lower-margin sectors, which could squeeze corporate profits.
Government belt-tightening. Massive spending initiatives have boosted demand for goods and services and corporate profits in recent years – and ballooned countries’ budget deficits in the process. As government spending begins to normalize, those corporate profit margins are likely to do so too.
Economic risks. A potential recession, higher-for-longer inflation that eats away at disposable income, or falling asset prices that reduce folks’ wealth could weaken consumer demand, forcing companies to cut prices and compressing margins further.
The end of tax cuts and cheap financing. Two big drivers of margin growth – ultra-low interest rates and major tax cuts – are unlikely to be repeated and might even reverse.
Sure, innovations are likely to push margins higher for both tech and non-tech firms. But a big chunk of that is likely to be offset by all the obstacles we’ve covered, and probably won’t be as impactful as some investors believe anyway. Look, even in the aftermath of the dot-com crash – when margins were low and tech advancements were booming – margins expanded only by 5% to 7% per year.
Overall, I’m reasonably optimistic. And I don’t expect margins to revert to their lower long-term average of 9.9%. After all, changes in sector composition and likely productivity gains mean “fair margins” will likely be higher now. But with the two biggest advantages (tax cuts and low borrowing costs) now gone, replaced by economic and political risks, the chances of margins expanding significantly from today’s elevated levels seem… slim.
This is not the forecast I’m the most confident about (and arguably the biggest wildcard), but as a baseline, let’s assume zero to 2% margin growth per year over the next decade (pushing margins to up to 15.6%%). This feels like a reasonable starting point.
The AI-driven productivity boost is likely to be offset by various challenges, so we’ll assume that profit margin growth on a trailing, 12-month basis (blue) will be zero to 2% over the next decade, pushing margins on the same basis (black) to a maximum of 15.6%. Source: Finimize.
Let’s put that together. If you mash up that 4% forecast for sales growth per share with the zero to 2% growth in profit margins, you can expect earnings growth of around 5% per year.
Earnings growth is likely to slow to 5% per year, in line with its long-term trend. Source: Finimize.
Driver #3: Valuations forecast
Expect a 1% to 2% slide, with risks leaning to the downside. As we saw earlier, valuations are the ultimate swing factor in driving ten-year returns, and the outside view isn’t exactly pretty: historical relationships suggest today’s high valuations (with the CAPE at a near-record 38x) hint at extremely disappointing returns. We’re talking well below 5% over the next decade.
Current valuations (CAPE at 38x) suggest nominal returns of less than 5% per year over the next decade for the S&P 500. Source: Finimize.
That said, the inside view offers reasons why US stocks might deserve higher valuations now than they’ve had in the past. The US economy is more tech-driven, with companies enjoying stronger margins, asset-light models, and better growth prospects. If inflation and interest rates normalize without major disruptions, AI-driven productivity gains could push both growth and earnings potential even higher, helping justify elevated valuations.
The problem is, these valuations leave no room for error. For multiples to expand much further, we’d need a flawless backdrop of high productivity growth, low inflation, low interest rates, and strong investor sentiment – an extremely optimistic combination to hope for. In reality, a lot could go wrong and send valuations lower: dwindling support from globalization and tax cuts could threaten margins, inflation and interest rates could settle at higher levels, the economy could fall into a deep recession, a financial crisis could pop up, or the AI bubble could burst.
To look at it from a different angle, let’s use a modified version of the widely trusted Gordon Growth Model, and estimate what today’s valuations imply for long-term earnings growth. Based on current data – including the risk-free rate (i.e. the yield on the benchmark 10-year Treasury), dividend yields, and a required risk premium of 4% – valuations are pricing in “perpetual” earnings growth of around 6%.
That may be lower than we’ve seen in other periods, but it’s still a tall order. The growth rate is far faster than what the overall economy can hope to achieve, and that’s not sustainable over the long haul – companies can’t become bigger than the economy. Expectations like these can be justified during exceptional periods – for example, during the Covid-19 rebound – but they can’t last forever.
Current valuations imply that earnings will grow much faster than the economy and at an exceptional rate consistent with its best-ever period. At left, implied earnings per share for US stocks. At right, implied earnings per share for the developed world (DW) stocks, excluding US ones. Sources: Bridgewater, Finimize.
Investor sentiment – the other big driver of valuation – isn’t helping the case, either. Optimism around AI-driven growth is so high that many investors seem willing to pay almost any price for the top names. That kind of enthusiasm – a classic Howard Marks bubble signal – suggests sentiment might be bordering on euphoria. Right now, the market seems to be brushing off risks, buoyed by AI hype and a resilient US economy. But the risks are often highest when investors feel they’re the lowest.
Our analysis in Part 1 shows that greedy behavior and euphoric sentiment are rarely justified – and that markets have a way of catching investors off guard. It’s also worth remembering: risks don’t always come from the usual suspects like inflation or economic growth ("known unknowns") but also from the shocks ("unknown unknowns") that no one sees coming.
So, with today’s relatively solid stock fundamentals, plus its high level of risk and investor enthusiasm, I see a bumpy road ahead for valuations, with potentially huge swings in sentiment and multiples. That said, I don’t expect valuations to settle at their old long-term averages either, with technology upending industries. Instead, I see “fair value” finding a loftier home than historically, likely with some temporary dips along the way. (Remember, valuations often swing between extremes.)
Over the next decade, it seems reasonable to expect valuations to be slightly lower than today’s levels, but still significantly above their historical norms. A CAPE around 35x and a standard price-to-earnings (P/E) ratio of 23x at the end of this period suggest valuations might subtract about 1% from returns per year. That seems a balanced, neutral starting point, and in my view, the risks lean heavily to the downside of that.
Stronger fundamentals suggest higher “fair valuations”, but the potential for further expansion is limited and risks are tilted to the downside. A 2035 CAPE (light blue) of 35x is arguably a reasonable neutral starting point. Source: Finimize.
Part 4: What does this mean for the S&P 500 over the next decade?
I made some reasonable assumptions, stress-tested the numbers, and found three likely scenarios. The base case (50% probability, 4%-7% annual returns) assumes steady sales growth, modest margin expansion, and a slight valuation decline. The downside case (30% probability, returns around zero) is what happens if margins shrink and valuations revert closer to historical norms. The upside case (15% probability, around 10% returns) would require AI-driven productivity gains and record valuations. A clear-eyed look at the numbers says it all: the blockbuster returns of the past decade are looking like a very long shot.
Base-case scenario: 4% to 7% per year with a 50% probability
In this scenario, EPS would grow 5% (driven by 4% sales growth and a 1% margin boost), valuations would edge down slightly to a 24x price-to-earnings (P/E) ratio from today’s 25.5x, and dividends would add a 1.3% yield. That mix gives an estimated annual return of 5.6% for my base case. Stress-test these assumptions – say, EPS growth between 4% and 6% and P/E ratios between 22x and 26x – and returns would land between 3.7% and 7.5%.
And, yeah, that’s a wide range, but even the upper end falls short of historical averages, aligning with the “below average” mode of past returns. Notice that this scenario assumes a relatively normal economy, without any big shocks. And it isn’t particularly pessimistic: it assumes record margins, valuations well above their long-term averages, and solid sales growth. But thanks to high starting valuations and record margins, we’re some distance from the 13% returns of the past decade.
My base case assumes record margins, valuations well above their long-term averages, and solid sales growth, and that translates into expected returns between 4% and 7% – well below historical averages. Source: Finimize.
Average growth in sales per share and record margins suggest 4%-5.5% earnings growth. Source: Finimize
Downside scenario: -3% to 3%, with a 30% probability
A more bearish scenario assumes that AI-driven productivity gains come up short – either taking longer or delivering less than markets expect. Combine that with some rising taxes, higher interest costs, stubborn inflation, or growing labor expenses, and corporate margins could shrink instead of expanding.
If margins dip to the 10%-12% range, from today’s 12.7%, and sales grow at just 2% to 4%, EPS growth would slow to 0% to 3%.
If margins dip to the 10% to 12% range, from today’s 12.7%, and sales grow at just 2% to 4%, EPS growth would slow to 0% to 3%. Source: Finimize.
That’d be much more sluggish than what current valuations are pricing, so investors would have to reprice their multiples lower, perhaps to around 16x or 20x. Throw that together, and you’d be looking at annual returns between -2% and 3%.
Below-average EPS growth and multiples reverting to their mean would translate into a return range of -3% to 3%. Source: Finimize.
And, look, this isn’t even a “doom and gloom” hypothetical: both margins and valuations would still be slightly above their longer-term historical average, and sales growth would be around average. But again, high starting valuations would means that any deviation from the rosy outlook could lead to very disappointing – and even negative – returns. And in my view, that scenario is a lot more likely than what the market’s currently pricing in.
Upside scenario: 8% to 11% with 15% probability
This one’s for the optimists. AI delivers on its promises and the macro environment favors the stock investor – pushing profit margins to a new 14% to 15% high and sales growth to an impressive 5% to 6%, translating into 6% to 8% EPS growth.
Record margins of 14% to 16% and above-average growth in sales per share of 5% to 6% would lead to EPS growth of 6% to 8%. Source: Finimize.
Such a strong environment might push valuations back to slightly above their all-time highs of the tech bubble, in the 30x to 32x range (with CAPE topping 45x).
Record high valuations and above-average EPS growth could push returns to the 8% to 11% range. Source: Finimize.
This rosy outlook depends on a lot going right in the next decade: AI delivering widespread productivity gains, the economy sidestepping any deep recessions, inflation and interest rates returning to normal, and optimism about the following decade staying high enough to keep valuations elevated. It’s possible, sure. But the downside scenario is arguably a lot more likely.
Repeat of the past decade scenario: 12% to 15% returns with a 5% probability
As you can see from the table, it’d take a serious stroke of good fortune to match the high returns of the past decade (above 11%). Even if margins expand to 15% and sales growth to 6% (bringing EPS growth to 7.8%), you’d need the P/E ratio to go significantly higher than its previous high (up to 36x). If you assume that multiples will settle at the max of the tech bubble, you’d need to see EPS growth of more than 10%, which would require both margins above 16% and sales per share growth of 7%. Like with the rosy scenario, it’s possible – it’s just not very likely.
You’d need margins above 16% and sales per share growth above 7% to see EPS growth of more than 10%. Source: Finimize
Even with 10% EPS growth, you’d need multiples to go significantly above their all-time highs for the S&P 500 to return more than 13% per year over the next decade. Source: Finimize
The conclusion is clear: today’s high valuations and record margins are weighing on the potential for further expansion while increasing the downside risks. Returns over the next ten years aren’t just likely to be below average: they’re extremely unlikely to be as high as the previous decade. In fact, they’ve got a 1 in 3 chance of being near zero.
And this isn’t based on any emotional bias or a “doom and gloom” outlook – it’s just a logical, data-driven take on what’s likely ahead. If you think the assumptions make sense (totally fair if you don’t), then this is a solid, reality-checked estimate. Sure, the future could throw us a curveball, but based on what we know now, this feels like a strong starting point.
Part 5: What does this mean for you?
This is a good time to check your expectations – or to come up with a Plan B. If you’re banking on 10%+ annual returns to fund your lifestyle, retirement, or financial goals, it’s time for a rethink. That could mean adjusting your spending, saving more, or finding a backup plan to bridge the gap. Alternatively, it’s a good time to diversify – yes, it’s boring, but it’s also effective. Let's look at how.
Now that you know that US stocks may be facing some major valuation headwinds, it’s worth considering ways to spread out your risks and tap into assets with better return potential.
Look across regions. Non-US stocks don’t face the same valuation challenges. Chinese stocks are incredibly cheap and have room to post high returns if the future ends up better than feared. European stocks are also trading at a discount and could outperform in different macroeconomic conditions.
Look across styles. Value stocks have been out of favor for a while, but now their valuations have them looking cheap – and they could rebound as their fundamentals improve.
Small-cap stocks are worth a look too: they have lower valuations and don’t carry nearly as much concentration risk as the mega-cap-heavy S&P 500.
Look across sector. An equally weighted S&P 500 index fund can give you exposure to America’s biggest companies, while not leaving you overexposed to tech’s behemoths.
Look across asset classes. Consider investing in a more balanced portfolio like The Easy Rider. Bonds have been offering attractive yields, commodities might soon benefit from supply constraints, and gold or bitcoin could be a good hedge against broader uncertainties.
You could also consider using momentum strategies to step out of stocks when things look dicey – for example, by using The Momentum Rider. Or, if you want to stay in US stocks but avoid the tech-heavy tilt, The Sector Momentum Edge lets you ride the sectors that are thriving in the current environment.
One final, important note: there’s no need to steer clear of US stocks or try to time them perfectly. But diversifying your asset mix and keeping your expectations in check – accepting the possibilities of lower returns and a bumpier ride – can help you stay on track with your investment goals. And, remember, if a market correction or bear market comes along, it could be a silver lining: resetting valuations and giving you a better entry point to lean back into America’s stocks.
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Capital at risk. Our analyst insights are for educational and entertainment purposes only. They’re produced by Finimize and represent their own opinions and views only. Wealthyhood does not render investment, financial, legal, tax, or accounting advice and has no control over the analyst insights content.
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