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With a price target of 6,500, Mike Wilson thinks the S&P 500 has relatively modest upside of around 9% in 2025.
But over the next 10 years, expect the benchmark index's annualized returns to be roughly flat, the Morgan Stanley CIO says.
There's a simple explanation for why: valuations, which account for much of how equities perform over a 10-year period, are historically elevated, he said. Wilson made the comments in an interview with the economist David Rosenberg earlier this month, and then reiterated his outlook in an interview with Business Insider this week.
"My comment on the podcast is not a controversial view based on valuations," he told BI. "That is a very common view, that given where valuations are today, over the next 10 years, the returns from point A to point B will be basically flat-ish, and on a real basis, maybe negative."
Below are a couple of valuation measures that Wilson cites. On the left is the forward 12-month price-to-earnings ratio. On the right is the Shiller cyclically adjusted price-to-earnings ratio, which compares the current prices to a 10-year rolling average of earnings to normalize outliers. Both measures are approaching levels seen at the peak of the internet bubble in 2000.
Morgan Stanley, Rosenberg Research
The Shiller CAPE ratio has proven very dependable in predicting long-term returns. Current levels around 37 put 10-year return expectations in the 2-3% range, according to the analysis below from Michael Finke, a professor of wealth management at The American College of Financial Services.
Michael Finke/Advisor Perspectives
As Wilson alluded to, he's not the first to warn of a sort of lost decade ahead for the broader market.
Goldman Sachs' David Kostin said in October that he sees the S&P 500 delivering 3% average annualized returns over the next decade. Compare that to 4.59% risk-free yield on 10-year Treasurys. Smead Capital Management's Bill Smead, a top-2% value investor, has also recently warned of poor annualized returns in the coming decade.
Some think calls like Kostin's are too bearish, however.
"There's no denying the stark relationship between P/E ratios and long-term forward returns, but an annualized return of 3% over the next ten years is likely too low," said Jeff Buchbinder, the chief equity strategist at LPL Financial, in an October 29 note. "Productivity gains from technology investments (artificial intelligence and otherwise) are likely to boost the profitability of S&P 500 companies and support both earnings growth and valuations."
While Wilson has a sour long-term outlook on the index level, he thinks certain areas of the market are better positioned than others to deliver robust returns in the years ahead.
"There will be plenty of opportunities to make money over that time in sectors and stocks even if the index is flat," he said.
Two underappreciated sectors right now are the energy and materials sectors, with their valuation levels relatively depressed. While the S&P 500's trailing 12-month PE ratio sits at 29.5, the same measure for the iShares S&P 500 Materials Sector UCITS ETF is 21.6, and the iShares U.S. Energy ETF is 10.7.
"If you were to be adding certain energy assets or materials assets here, yes, I think your odds of making pretty good money over the next 3-5 years are quite high," Wilson told BI.
Spending on AI infrastructure will benefit the sectors, he said.
"It doesn't happen magically without energy and materials," Wilson said.
Wilson also said international stocks, particularly some emerging markets, are trading at attractive prices. India is one that he believes is in a bull market trend. And China could start to turn around eventually, he said.
"China is the one that everyone's kind of trying to figure out," he said. "I don't know when it starts, but I wouldn't count the Chinese stock market out completely, and I think there will be opportunities there."
As of November 29, the MSCI Emerging Markets Index traded at a 15.3 trailing 12-month PE ratio.
