Elevated stock market valuations suggest that returns for investors over the next decade could be meager, according to a Bernstein analysis. Using a gauge of longer-run earnings per share expectations known as the Shiller PE Ratio, the firm said the prospects that corporate profits can justify current valuations are growing dim. In practical terms, that means a market that has been generating roughly 12% in total returns for the past 10 years could be looking at something closer to 4% for the coming decade, a steep drop-off that will force investors to look elsewhere to keep up. “Long-run valuation indicators suggest that equity returns are expected to be lower over the next decade,” analysts Sarah McCarthy and Mark Diver said in a Wednesday client report. “Equity valuations are lower outside the US indicating that longer-run returns may be more attractive in other regions.” The Shiller PE or CAPE — that is, cyclically adjusted price to earnings ratio — sets the market multiple based on average inflation-adjusted earnings over the course of a decade. That means it doesn’t reflect short-term market moves but rather is based on longer trends that develop over time. Whereas the standard P/E ratio for the S & P 500 is around 21 now, the Shiller adjustment puts it close to 32. That compares to an average historical value of 17. “The Shiller PE has historically been a good predictor of very long-run 10-year forward equity returns,” the Bernstein analysts wrote. “The Shiller PE takes a long-term view of earnings (uses the average earnings over the past 10 years), and uses an inflation-adjusted measure, so it is not influenced by short-term swings.” However, the firm notes that investors shouldn’t forego stock market exposure even if returns are likely to be lower. “Equity returns are expected to be lower over the next decade than we have seen over the previous decade. Higher inflation however warrants continued exposure to equities,” the analysts said. “Current household allocation to equities is high but below peak levels indicating some scope to increase allocation.” To be sure, the Shiller indicator is not infallible. The ratio has been on a steady climb higher ever since the end of the financial crisis in 2009, a period during which equities staged their longest bull run in history until the Covid pandemic brought it to a close. Ed Yardeni of Yardeni Research said market valuations could be resetting as Big Tech companies powered by artificial intelligence dominate the market. “In the Brave New World of AI, investors seem to be willing to pay a higher valuation multiple for earnings, especially of the MegaCap-8. Could it be that the historical fair-value P/E of 15.0 is history?” Yardeni wrote in a Tuesday note. “It might be in the Roaring 2020s dominated by the MegaCap-8, which currently account for a record 27% of the market cap of the S & P 500 and sport a 31.2 forward P/E (chart). The S & P 500’s forward P/E with and without them is 19.2 and 16.7.” Yardeni is expecting at least the near-term trend to be much higher. He has raised his S & P 500 price target for the end of 2024 to 5,400, implying a nearly 19% return from here. If that hits, he sees the index jumping to 5,800 by 2025, or 27% from Tuesday’s close.