S&P 500's era of hot returns is over, Goldman says

• Goldman's forecast implies the S&P — the benchmark index tracked by many of the world's most popular investment vehicles — is more likely than not to have lower returns than U.S. Treasury securities (72% odds) and could even deliver returns lower than inflation (33% odds) through 2034.

State of play: The forecast incorporates some of the standard variables portfolio strategists look at to project future returns — price-to-earnings-ratios and interest rates, primarily. But much of the subpar projection is rooted in the extraordinary concentration of the recent stock market runup.

• Stocks of a handful of fast-growing, highly profitable tech giants that are investing heavily in artificial intelligence — Apple, Amazon, Microsoft, Nvidia, Alphabet, and Meta — increasingly are the S&P.
• The index may be meant to contain 500 stocks, but those plus Berkshire Hathaway, Tesla, and a couple of others have accounted for around a third of the total market-cap weighted index in recent months.

Flashback: The Goldman team notes that in past episodes in which the market became highly concentrated, the megafirms that drove gains weren't able to continue achieving the outsized growth in sales and profit margins that would have propelled further gains.

• In the 1960 and early 1970s, the "Nifty Fifty" were large cap superstar companies, including names like IBM, Eastman Kodak, and Xerox. The 1970s ended up being a lost decade for stock market returns.
• The late 1990s tech boom sent shares of Microsoft, General Electric, Cisco Systems, and Intel to the moon, but the 2000s were also a deflating time of weak returns.

What they're saying: "Our historical analyses show that it is extremely difficult for any firm to maintain high levels of sales growth and profit margins over sustained periods of time," write David Kostin, Goldman's chief U.S. equity strategist, and four colleagues.

• "The same issue plagues a highly concentrated index," they write. "As sales growth and profitability for the largest stocks in an index decelerate, earnings growth and therefore returns for the overall index will also decelerate."

While the Goldman note has received lots of attention, the core idea — that subpar returns are likely ahead for the biggest U.S. stocks — is so widespread as to be practically conventional wisdom among those who analyze asset allocation.

• For example, Vanguard routinely updates its projected returns on different asset classes and currently only anticipates 3% to 5% returns for large-cap U.S. stocks (i.e., the S&P 500) over the coming decade.
• Vanguard sees substantially better returns ahead on value stocks, small caps, Real Estate Investment Trusts, and international stocks.

Between the lines: The flip side of the explosive growth in valuations of U.S. mega-caps over the last 15 years is that pretty much everything else, with more modest returns in that time, still has valuations that offer meaningful upside.

• Those of us who studied our Modern Portfolio Theory and built a portfolio strategically diversified based on factors like geography and company size have suffered subpar returns over the last 15 years relative to people who just piled everything into the S&P.
• In effect, the Goldman and similar forecasts are a prediction that the worm has turned, and the decade ahead will reward that diversification.

Yes, but: Maybe the AI revolution will involve winner-take-all effects and such massive capital spending needs that the winners of the last decade will also be the winners of the next decade, propelling the S&P much higher despite historical warning signs.

The bottom line: In deciding whether to go all-in on the S&P or diversify your stock investment more among value-oriented, smaller, and international companies, you are implicitly betting on one of those narratives.