The stock market's going to be dishing out subpar gains for the foreseeable future.
That's the take from Goldman Sachs' (GS 1.56%) recent outlook, anyway. The investment banks' analysts expect the S&P 500 (^GSPC 1.56%) to log an average annual gain of only 6.5% over the coming 10 years, down from its long-term annualized pace of around 10%. But why? For some of the reasons you might readily guess (like steep valuations), but also some that aren't quite as obvious.
It's not exactly a reason to panic, though. See, Goldman's also got some tips to help you navigate this soft patch, and perhaps even beat this broad average.
Image source: Getty Images.
Here comes the valuation headwind
It's a tired argument, but a reasonable one all the same -- as a whole, U.S. stocks are expensive right now. Goldman's number-crunching indicates the S&P 500's trailing price-to-earnings ratio stands near a multiyear high of 23.
And yes, Goldman Sachs analysts also acknowledge that it's a small number of massive companies involved in the artificial intelligence (AI) revolution that are responsible for the broader valuation problem. It just doesn't matter. If and when these stocks finally suffer their long-overdue valuation correction, it will take a while, and will likely create a ripple effect that drags on the rest of the market ... and the economy itself. Specifically, Goldman believes shrinking premium valuations will effectively work against the market's net progress by about 1% per year through 2035.
Then there are interest rates. As the report goes on to explain, much of the widening of the S&P 500's profit margins since 1990 "has been attributable to falling interest rates and corporate tax rates, neither of which appears likely to decline as substantially during the next decade."
Investors had to know this day of reckoning was coming sooner or later, of course.
And yet, Goldman isn't exactly discouraging investors from getting into and remaining in the stock market. It's just saying investors might want to adapt accordingly, by favoring stocks other than the market's present darlings.
Time for some strategic tweaking
The thing is, the lackluster outlook in question is mostly an American-centric concern. Plenty of other regions are expected to fare better, like Japan, as well as the rest of Asia. Their average market growth outlooks for the coming 10 years are 8.2% and 10.3%, respectively, while emerging markets are expected to dish out average annualized returns of 10.9% through 2035, all led by raw earnings growth.
This dynamic puts foreign stocks like China's Alibaba (BABA 3.53%) and South America's MercadoLibre (MELI 8.54%) -- the so-called Amazon of Latin America -- into the spotlight. While Alibaba's roots are in the e-commerce realm, its top growth engine for the coming decade is likely to be artificial intelligence. It's even developed its own AI processing chip that's competitive with hardware made by Nvidia. Meanwhile, MercadoLibre is capitalizing on the rapid proliferation of web-connected smartphones in South America, driving its top line 39% higher (or 49% higher on a constant-currency basis) for the three-month stretch ending in September alone, extending well-established trends.
NYSE: BABA
Key Data Points
MercadoLibre and Alibaba also bring something else strategic to the table. That's the fact that both American depositary receipts -- or ADRs -- are denominated in U.S. dollars at a time when Goldman's strategists feel the greenback is about 15% overvalued. As this premium unwinds and reinflates other countries' currencies, it could add approximately 2 percentage points' worth of net growth to most foreign stocks every year through 2035.
Then there's the other outcome of this paradigm shift. Although Goldman's researchers didn't explicitly recommend dividend stocks as a means of beating the market for the next 10 years, the report repeatedly points out that dividends will make up an important part of the total returns from every region's stocks during the decade ahead.
This bodes well for dividend-focused companies like Coca-Cola (KO +0.14%) as well as drugmakers like Pfizer (PFE 1.93%) and Merck (MRK 0.08%). In fact, both pharmaceutical stocks offer above-average yields right now thanks to weakness linked to unwarranted worries that neither has the brightest of foreseeable futures. They do! Merck, for instance, contends its current developmental pipeline could be generating as much as $50 billion in yearly revenue by the mid-2030s, eventually replacing its cancer-fighting Keytruda, which currently accounts for half of its sales but will begin losing the crux of its patent protection in 2028. Its dividend payments should remain intact.
Don't panic -- just adapt
Like any other outlook, take Goldman's with a grain of salt. It acknowledges it's only a best guess using information that's currently available, and could ultimately be wrong.
Still, as veteran investors can attest, the market is forever changing. While philosophical strategies like index-based investing with instruments such the SPDR S&P 500 ETF Trust (SPY 1.54%) never really go out of style even in subpar market environments, it would be naïve to believe the next few years will look precisely like the last few have when so much has changed... like interest rates, the U.S. government's massive debt overhang, tense trade relations, and the advent of AI that's made so many foreign companies surprisingly competitive so quickly. As an investor, you should be willing to recognize and adapt to these changes as merited, perhaps beginning with what you expect from the U.S. stock market's most important health barometer for the foreseeable future.
