Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 599

Mapping future US market returns

Over the last 15 years, the US stockmarket has come to dominate global passive portfolios, with its weight in the MSCI World Index rising from below 50% to nearly 75%. That ascent was driven by exceptional returns. Since 2010, the S&P 500 has returned 13.8% per annum—much higher than markets elsewhere, exceptionally high versus its own history and inflation, and a near-record result against bonds and cash.


Source: MSCI.com, as of 31 December 2024.

Charts showing the S&P’s staggering performance are easy to find, often with the implicit message that what goes up must come down. That’s both unsatisfying and not how markets work.

The key drivers for US outperformance

It’s more useful to understand what drove those returns, and what investors need to believe to expect similar returns again. As we’ve written before, equity returns come from just three sources: fundamental growth, change in valuation, and dividends. We can get a slightly clearer picture here by splitting fundamental growth into sales growth and change in margins. So where did the S&P’s 13.8% p.a. come from?

The first driver was sales growth. American companies grew their sales by 5.2% p.a.—a little low versus history, but then so was inflation. To see what happened to earnings, we need to look at margins. In 2010 net profit margins were 9%. Over the following years, margins expanded dramatically, to about 13%. Margins going up boosted returns to the tune of 2.5% p.a.

Putting sales and margins together gives us earnings. To get price, the next piece is the price-earnings ratio. In 2010 the S&P traded at 15 times trailing earnings. Valuations have since got much more expensive, and the US market now trades at 25 times earnings. Rising valuations kicked in 3.6% p.a. to the S&P’s stellar return. The last piece is dividends, which contributed 1.9% p.a.

Scenarios for future returns

Now, let’s say we want to re-run history. What do we have to believe to expect 13.8% p.a. again?

Sales growth and dividends are reasonably stable, so let’s say they contribute at the same rate as the past cycle. That leaves changes in margins and changes in valuations.

For margin expansion to boost returns by 2.5% p.a. again, margins need to go up again, from today’s much higher starting point. Margins are cyclical, and they are currently near record highs. Doing the numbers, a boost of 2.5% p.a. would require net profit margins at 18% by 2040—higher than the US has ever seen.

Similarly, for rising valuations to boost returns by 3.6% p.a. again, valuations need to go up again, from today’s much more expensive levels. At 25 times trailing earnings, the S&P’s current valuation has only been eclipsed at the top of the tech and Covid bubbles. To expect another 3.6% p.a. boost to returns, valuations need to end up at 40 times earnings. Again, this would be a record by some distance.

Putting it together, roughly half of the S&P’s tremendous recent returns came from rising margins and valuations. If we want a re-run, we have to expect net margins to reach 18% and valuations to hit 40 times earnings. Crazier things have happened, but it’s tough to make the numbers work.

What if margins and valuations don’t help, but don’t hurt either? If both stay at their current near-record levels, that would leave sales growth and dividends to drive returns. Sales and dividends chugging along would suggest returns of 7.2% p.a. That’s normal over the very long term, but it’s roughly half what we saw over the latest period. And that’s if valuations and margins stay very, very high.

What if they fall to 20-year-average levels? That captures the period since Google’s listing where highly profitable, highly valued tech businesses have been ascendant. If margins and valuations fall, the numbers suggest a 3.4% p.a. long-term return for the S&P—less than the yield on US Treasury bonds. Said another way, the broad US stockmarket is dependent on great expectations. Great expectations are already in the price, so to expect a great return, investors need to believe that reality will prove even more amazing than markets already expect.

A few things could help there. Sales growth has often been higher historically. Companies are the ones raising prices, so they can usually more or less capture inflation through sales growth. Higher sales growth from inflation would boost the S&P’s absolute return, but not its real return.

Margins could continue to climb. A corporate tax cut helped before and could again. But strategies to reduce corporate taxes also reduce the benefit of any corporate tax cuts. Huge and hugely profitable companies could continue to thrive, pulling up the average margin for the market. But society does not suffer ever-rising profit margins forever. Monopoly-like margins attract competition and regulation, politicians dislike rival power centres, and workers dislike prices and profits growing faster than wages.

Expectations in the US are high, and when expectations are high, so is risk. Fortunately, low expectations are easier to find pretty much everywhere else. Stocks outside the US are cheaper, whether you weight them equally, by size, or look just at the ‘value’ or mid-sized companies. The US is not fruitless—some of our highest-conviction holdings are American companies. But generally we’ve found other markets to be more fruitful hunting grounds for undervalued ideas. We are far happier seeking low expectations.

 

Eric Marais is an Investment Specialist at Orbis Investments, a sponsor of Firstlinks. This article contains general information at a point in time and not personal financial or investment advice. It should not be used as a guide to invest or trade and does not take into account the specific investment objectives or financial situation of any particular person. The Orbis Funds may take a different view depending on facts and circumstances.

For more articles and papers from Orbis, please click here.

 

RELATED ARTICLES

Through the looking-glass: what counts is not tied to an index

Australian large caps outperform small caps over long term

banner

Most viewed in recent weeks

Raising the GST to 15%

Treasurer Jim Chalmers aims to tackle tax reform but faces challenges. Previous reviews struggled due to political sensitivities, highlighting the need for comprehensive and politically feasible change.

100 Aussies: seven charts on who earns, pays, and owns

The Labor government is talking up tax reform to lift Australia’s ailing economic growth. Before any changes are made, it’s important to know who pays tax, who owns assets, and how much people have in their super for retirement.

Here's what should replace the $3 million super tax

With Div. 296 looming, is there a smarter way to tax superannuation? This proposes a fairer, income-linked alternative that respects compounding, ensures predictability, and avoids taxing unrealised capital gains. 

Which generation had it toughest?

Each generation believes its economic challenges were uniquely tough - but what does the data say? A closer look reveals a more nuanced, complex story behind the generational hardship debate. 

9 winning investment strategies

There are many ways to invest in stocks, but some strategies are more effective than others. Here are nine tried and tested investment approaches - choosing one of these can improve your chances of reaching your financial goals.

Chinese steel - building a Sydney Harbour Bridge every 10 minutes

China's steel production, equivalent to building one Sydney Harbour Bridge every 10 minutes, has driven Australia's economic growth. With China's slowdown, what does this mean for Australia's economy and investments?

Latest Updates

Retirement

The best way to get rich and retire early

This goes through the different options including shares, property and business ownership and declares a winner, as well as outlining the mindset needed to earn enough to never have to work again.

Shares

Boom, bubble or alarm?

After a stellar 2025 to date for equities, warning signs - from speculative froth to stretched valuations - suggest the market’s calm may be masking deeper fragilities. Strategic rebalancing feels increasingly timely.

Property

A perfect storm for housing affordability in Australia

Everyone has a theory as to why housing in Australia is so expensive. There are a lot of different factors at play, from skewed migration patterns to banking trends and housing's status as a national obsession.

Economy

Which generation had it toughest?

Each generation believes its economic challenges were uniquely tough - but what does the data say? A closer look reveals a more nuanced, complex story behind the generational hardship debate. 

Shares

Is the iPhone nearing its Blackberry moment?

Blackberry clung on to the superiority of keyboards at the beginning of the touchscreen era and paid the ultimate price. Could the rise of agentic AI and a new generation of hardware do something similar to Apple?

Fixed interest

Things may finally be turning for the bond market

The bond market is quietly regaining strength. As rate cuts loom and economic growth moderates, high-quality credit and global fixed income present renewed opportunities for investors seeking income and stability. 

Shares

The wisdom of buying absurdly expensive stocks (or not!)

Companies trading at over 10x revenue now account for over 20% of the MSCI World index, levels not seen since the dotcom bubble. Can these shares create lasting value, or are they destined to unravel?

Sponsors

Alliances

© 2025 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. To the extent any content is general advice, it has been prepared for clients of Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), without reference to your financial objectives, situation or needs. For more information refer to our Financial Services Guide. You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.