Goldman Sachs forecasts low long-term S&P 500 returns (3-6.5% annually). The key reason is that today's high market concentration implies higher future volatility, yet investors aren't being compensated for this risk because current valuations are already historically high and likely to contract.

Contrary to popular belief, earnings growth has a very low correlation with decadal stock returns. The primary driver is the change in the valuation multiple (e.g., P/E ratio expansion or contraction). The correlation between 10-year real returns and 10-year valuation changes is a staggering 0.9, while it is tiny for earnings growth.

For the first time in a decade, European equities have broken out of their constantly widening valuation discount range compared to the US. Historically, such breakouts have signaled the beginning of a long-term upward trend where the valuation gap narrows significantly.

Historically, US earnings outgrew the world by 1%. Post-GFC, this widened to 3%. Investors have extrapolated this recent, higher rate as the new normal, pushing the US CAPE ratio to nearly double that of non-US markets. This represents a historically extreme valuation based on a potentially temporary growth advantage.

Following a 30-40% valuation surge in 2025, China's market is expected to stabilize. Further upside in 2026 will depend on corporate earnings, projected at a modest 6%, signaling a shift from a valuation-driven to an earnings-driven market that requires a different investment approach.

Contrary to popular belief, when measured in constant currency, European equities have outperformed their US counterparts since the last US elections. This trend is not widely recognized by investors, setting the stage for a potential re-evaluation of the region.

Despite significant media attention on its strong performance, the American stock market was outperformed by many others globally in 2025. Israel's stock market, for instance, had the best year, challenging the common perception that the US market is the default leader in annual gains.

The top investment idea for the year is European equities, specifically quality stocks. This is based on a favorable combination of accelerating earnings growth, supportive fiscal and monetary policy, and more attractive valuations compared to US markets, particularly when analyzing EPS growth plus dividend yield versus P/E multiples.

Morgan Stanley's 2026 outlook suggests a strong US market will create a "slipstream" effect, lifting European equities. This uplift will come from valuation multiple expansion, not strong local earnings, as investors anticipate Europe will eventually benefit from the broadening US economic recovery.