The spectacular performance of U.S. equities has delighted advisors and their clients. Fueled by the prospect of lower rates, strong consumer spending, resilient corporate earnings and soaring sentiment for AI-related stocks, the U.S. stock market rebounded from the 2022 bear market with a 26.6% annualized return (measured in U.S. dollars) over the past two years.
Longer-term performance is also enviable, with a 15.3% annualized return over the 10 years ended September 30, 2025.
However, when one digs into the components of the long-term returns, it becomes clear that the future will likely be different.
Three things to consider.
First, nearly 25% of the 10-year return to date, 3.8% a year, was due to expanding valuations as investors poured capital into stocks, particularly index ETFs. By Sept. 30, the trailing price-earnings ratio for the S&P 500 reached an extremely expensive 26.8, a lofty 21% above the 10-year average of 22.1.
Several studies have found that stock valuations exhibit mean reversion over longer periods. A contraction back to the 22.1 average a decade from now would result in an annual return reduction of -1.9%. A faster reversion would erode returns even more.
Second, there is a lower starting dividend yield. The annual dividend yield on the S&P 500 a decade ago was 2.2%. Today it is a paltry 1.2%.
And third, we anticipate a slower earnings growth rate. Over the past 10 years, operating earnings per share for the S&P 500 grew at a robust 9.1% a year. Although this reflects the increasing innovation and productivity of U.S. businesses and the growing dominance of a small number of highly profitable mega-cap tech stocks, research has found that in fact low interest rates and tax reductions were a significant factor in boosting earnings growth.
In the future, higher interest rates will cut earnings growth while the fiscal challenges of the U.S. suggest meaningful corporate tax reductions are unlikely. At some point, taxes will likely increase. The growth of earnings per share has already dropped to 7.1% a year over the past three years.
Storm clouds
In combination, these numbers indicate that the U.S. market is likely to deliver low- to mid-single digit long-term returns now. Also, there are storm clouds on the horizon which could trigger a faster correction to valuations and generate poor short-term returns.
These include:
- Monetary tightening. If inflation proves more persistent than expected or begins to rise again, the U.S. Federal Reserve may have to raise interest rates further or maintain elevated rates for longer. This would increase borrowing costs, reduce corporate profits and compress equity valuations — particularly in high-growth sectors like technology.
- Market concentration. The current rally has been disproportionately driven by a handful of mega-cap tech stocks, many of which are tied to the AI boom. If investor sentiment shifts — for instance, due to worries over the enormous capital expenditures required to create AI infrastructure, earnings disappointments, regulatory crackdowns due to AI risks or rapid technological changes making massive capital investments obsolete — these stocks could tumble, dragging down the broader indices.
- Geopolitical instability. Escalating tensions between the U.S. and China, expanding conflicts in Eastern Europe, a sovereign debt crisis in Europe or a surprise event like a cyberattack on financial infrastructure could trigger panic selling. Markets are highly sensitive to uncertainty, and geopolitical shocks often lead to rapid repricing of risk.
- Energy sector vulnerability. Massive investment in data centres is straining power grids and increasing reliance on fossil fuels. Energy bottlenecks, environmental backlash or consumer upset over escalating utility costs could undermine the AI narrative and lead to asset write-downs.
- Consumer weakness. The combination of rising unemployment, disappearing entry-level jobs, higher interest rates, student loan repayments and declining savings could erode demand and corporate earnings. Consequently, the market may reprice expectations for growth.
Advisors should ensure that their allocations to the U.S. stock market are looking forward rather than backwards. Rebalancing among asset classes, regional equity allocations and styles is essential. Higher exposures to the Canadian, international developed and emerging market equities, as well as real estate, infrastructure and gold may be in order.
Michael Nairne, RFP, CFP, CFA, is a co-founder and CIO of Tacita Capital Inc., a private family office, and manager for TCI Premia Portfolio Solutions.