How the S&P 500’s Return Over the Next Decade Could Be Just 1% a Year Average

The continuous expansion of profit margins in Corporate America cannot persist indefinitely, which carries pessimistic implications for the stock market.

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According to S&P Dow Jones Indices, the operating profit margin of the S&P 500 for the first quarter of 2024 stood at 11.76%, reflecting a return to its long-term trendline after fluctuations associated with the economic impact of Covid-19 and subsequent stimulus measures. This margin, higher than those of 2023 and 2022, suggests a potential increase to over 12% for the entire year, well surpassing the 30-year average of 8%. Analysts, including John Butters from FactSet, anticipate margins of 12.2%, 12.6%, and 12.5% for the following quarters.

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The stock market's current elevation heavily relies on the expansion of profit margins. If the margin mirrored that of 30 years ago, the S&P 500 would be valued significantly lower today.

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Economists have questioned the sustainability of rising profit margins, particularly as they've been accompanied by a decline in labor's share of income over the past three decades. Rob Arnott of Research Affiliates suggests that margins may revert to historical norms rather than continue to climb indefinitely.

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Concerns about the stock market's future often revolve around projections of how much it would decline if profit margins returned to historical averages. However, even if margins simply plateau, rather than decline, it would still translate to below-average returns in the coming years.

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This is because future stock market growth relies on either expanding price-to-earnings (P/E) multiples or corporate sales growth, both of which offer limited optimism for a robust bull market in the next decade. The current P/E ratio of the U.S. market is already at historic highs, leaving little room for further expansion. Additionally, sales growth is expected to be sluggish, historically lagging behind overall economic growth, which is projected to slow down in the coming years according to estimates from the Congressional Budget Office.

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If these projections hold true, and assuming the P/E ratio remains stable, the inflation-adjusted annualized return for the S&P 500 over the next decade could be as low as 1.3%.

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