We are pleased to present our new report, “Long-Term Equity Outlook,” which offers a comprehensive analysis of the factors shaping equity market performance. This document provides an in-depth look at the challenges and opportunities facing U.S. and international equity markets over the long term. Below is the Executive Summary to highlight key insights from the report.
Download the complete Long-Term Equity Outlook report here:
Executive Summary
Chief Investment Officer
U.S. equity markets are under mounting pressure from demographic shifts, political instability, and economic challenges. Investors now face the need to reassess their long-term outlook for returns.
Typically, Earnings Per Share (EPS) growth and Price-to-Earnings (P/E) ratios drive equity returns. However, both these factors face significant challenges in the U.S., especially with aging demographics, political uncertainty, and possible shifts in economic fundamentals. Although U.S. equities have historically outperformed, future prospects appear uncertain. Market dynamics, including de-dollarization, geopolitical tensions, and rising debt risks, threaten current valuations.
In contrast, some developed markets may offer better conditions. These markets benefit from lower P/E ratios, stronger immigration trends, and more stable demographics. Thus, today’s investors must decide whether to stay invested in U.S. equities with their inherent risks or shift focus to international markets that may provide structural advantages for higher long-term returns.
This article examines the key drivers of equity performance. Moreover, we explore the unique risks in U.S. markets and assess why some developed economies, particularly Australia and the UK, may offer stronger opportunities in the coming years.
Short vs Long-term Outlook
While short-term market movements capture headlines, it’s the long-term equity returns that truly shape wealth over decades. These long-term forces can diverge significantly from near-term market trends, and in today’s U.S. market, their outlook is increasingly uncertain.
Equity returns are driven by two fundamental factors: Earnings Per Share (EPS) growth and changes in the Price-to-Earnings (P/E) ratio. Both elements carry significant risks in the U.S., while these risks appear more contained in other developed markets.
Long-term Equity Returns in the US
Earnings Per Share ultimately reflect the profitability of underlying companies. A rising economy tends to lift all ships, increasing EPS across the board. However, companies in the S&P 500 have consistently outpaced overall economic growth over the last 30 years. While the U.S. economy has grown by an average of 4.5% per year, EPS for S&P 500 companies has expanded at 7% annually during the same period.
The S&P 500’s outperformance can be attributed to globalization and neoliberal policies, which allowed large corporations to capitalize on favorable regulations, taxation, and labor markets. While economic theory suggests that higher corporate profits should drive increased investment in labor and infrastructure—leading to higher wages, interest rates, and commodity costs—corporations have managed to increase earnings without corresponding increases in wages or input costs. As a result, corporate earnings have doubled over the past three decades. The biggest potential threat to corporate earnings is antitrust enforcement, but this is unlikely to be a significant risk given the lack of public pressure to break up monopolistic firms.
Political risks, particularly a democratic downgrade, could also impact EPS through lower growth and currency depreciation. While the U.S. has largely been immune to political risks thus far, a rapid deterioration in democratic institutions or extreme political polarization could undermine the stability that has historically supported U.S. corporate profitability.
Valuation Risk: The Role of P/E Compression in Future Returns
The P/E ratio presents an even more significant risk to equity returns than EPS. The current P/E ratio for the U.S. stands at 24x trailing 12-month earnings, compared to the 30-year average of 19x. Several factors could drive the P/E ratio back to its historical average or even below, including:
- An aging population, particularly among baby boomers, which could reduce demand for equities in favor of fixed-income investments.
- Economic uncertainty, driven by political instability, which could reduce investor confidence and compress valuations.
- De-dollarization, as geopolitical factors and de-globalization trends encourage other countries to reduce their reliance on the U.S. dollar.
- A potential government debt crisis, where higher treasury yields drive up equity yields, compressing equity multiples.
Structural Demographic and Political Risks to Valuation
Among these risks, according to many institutions, an aging population seems to pose the greatest threat to long-term equity valuations. As baby boomers shift their portfolios towards fixed income, global demand for equities could decline, reducing the P/E ratio. Currently, U.S. households hold record-high equity allocations, but this trend is likely unsustainable as the population ages.
Economic and political uncertainty is another threat to current valuations. Democratic downgrade could lead to increased financial risk, further reducing P/E ratios. This is closely linked to de-dollarization and de-globalization, as international investors may withdraw from U.S. markets if political conditions worsen significantly. Still, this risk would not have significant effects on the financial markets if the political situation in the US remains similar or less concerning than that of the rest of the developed world.
The last risk is a US debt crisis. Current high federal deficits could lead to a debt crisis where the US defaulted on its debt, greatly increasing borrowing costs. When treasury yields increase, so do equity yields. And equity yields are inversely proportional to equity multiples. Although changes in treasury yields do not tightly bind equity yields, a large change in UST yields could have a moderate impact on equity valuations.
Developed Markets Comparison
Other developed markets offer potentially higher equity valuations due to three main factors: lower starting P/E ratios, strong economic growth driven by immigration and stable policies, and slower aging populations. While these factors vary across markets, they collectively present a more favorable outlook for long-term equity returns compared to the U.S.
Countries such as Australia, the UK, Germany, Canada, Japan, the Netherlands, and Switzerland currently have lower P/E ratios than the U.S., with the UK, Australia, and Germany offering the lowest valuations.
In terms of economic growth, most developed markets are projected to grow at rates comparable to or below the U.S. However, countries like Australia and Canada are expected to outgrow the U.S., while Japan is projected to experience the slowest growth among developed markets.
Aging populations represent a significant risk to equity returns across developed markets. Japan, having already experienced demographic aging, is expected to see less demographic decline moving forward. In contrast, the UK, Australia, Canada, and France are expected to age at a moderate pace, while other European countries will face more pronounced aging challenges.
Immigration plays a critical role in mitigating demographic risks. Many developed markets benefit from positive immigration trends, which help offset aging populations and bolster economic growth.
The UK and Australia stand out as markets with the most favorable combination of lower valuations, economic growth, and slower aging making them strong candidates for higher equity returns. Germany, France, and Canada are also expected to outperform the U.S., while Japan, the Netherlands, and Switzerland are projected to see moderate returns.
Conclusion
Many analysts predict a mean reversion in U.S. equity valuations, with the P/E ratio potentially falling to its historical average of 19x or slightly lower due to the risks outlined. Hence, we recommend a neutral or underweight position on U.S. equities. In contrast, we recommend an overweight position on certain developed markets, particularly the UK and Australia, with Germany, France, and Canada offering additional opportunities. Continuous monitoring is essential to ensure that the positive factors supporting valuations in these markets remain intact.
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This material is for informational purposes only and does not constitute financial, legal, tax, or investment advice. All opinions, analyses, or strategies discussed are general in nature and may not be appropriate for all individuals or situations. Readers are encouraged to consult their own advisors regarding their specific circumstances. Investments involve risk, including the potential loss of principal, and past performance is not indicative of future results.