Goldman Sachs strategists recently forecast their expected return for the S&P500 for the next 10 years, and it was not optimistic. The investment bank projects that the S&P will only produce an average annual return of 3% over the next decade. That’s well below the index’s return of about 13% over the past 10 years and also well below its historical return of 11%.

Additionally, Goldman’s forecast is down from the 8% average annual return it previously expected. He cited the high concentration of leading technology companies among the S&P’s top 10 stocks as well as a higher starting point for the index after recent strong returns. Goldman strategists noted that the 36% concentration among the index’s top 10 stocks was the largest since the 2000 dot-com boom.

Goldman estimates that the equal-weighted S&P index, in which all stocks are weighted equally, would outperform the market-cap-weighted S&P index. Continuing its gloomy forecast, the investment bank said there was a 72% chance the S&P 500 index would underperform Treasury bonds and a 33% chance it would fail to keep up with inflation.

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What should an investor do?

If you’re like most investors, a fund that tracks the S&P 500 index, such as Vanguard 500 S&P 500 ETF (VOO -0.91%)is probably an essential part of your portfolio. As such, Goldman’s gloomy prediction might worry you. However, there are several reasons why Goldman’s prediction will likely turn out to be wrong.

On the one hand, Goldman cited a higher starting point for the index, but currently the market is only two years into a bull market. A bull market typically lasts about three to four years, which would indicate that, based on history, investors still have a few more years ahead of them. However, some more recent bull markets have actually lasted much longer. For example, the bull market that began in 1987 lasted more than 12 years, and the bull market that began after the Great Recession lasted about 11 years.

Meanwhile, the S&P tends to do well when the Federal Reserve cuts rates as part of a rate normalization cycle, which appears to be the case. During the last three periods of Fed rate cuts aimed at normalizing policy, the S&P rose between 5% and 15% per year after the Fed’s first rate cut.

Although Goldman didn’t explicitly state it, its forecast appears to incorporate a correction for major tech stocks – investment bank strategists hint a dot-com meltdown could happen with artificial intelligence (AI). However, there are many differences between the AI ​​boom and the dot-com boom.

One is assessment. For example, Nvidiawhich is the primary beneficiary of AI infrastructure development, currently trades at a forward price-to-earnings (P/E) ratio of 35. This compares to Cisco Systemswhose hardware was the backbone of building the Internet, trading at a peak forward P/E of 150 in 2020. Microsoftmeanwhile, was trading at around 75 times earnings, while today it trades at a P/E of 35.

MSFT PE ratio data by YCharts

At the same time, there appears to be no slowdown in AI spending. The main reason is that for technology to continue to improve and AI models to advance, they simply need exponentially more computing power to train. With many companies looking to win the AI ​​race, we can expect this spending to continue for many years to come and only increase.

Why market cap-weighted indices work

Another potential flaw in Goldman’s argument is the prediction that an equal-weighted S&P index would outperform. Investors can now purchase equally weighted S&P 500 exchange-traded funds (ETFs), such as Invesco S&P 500 Equal Weight ETF (R.S.P. -0.33%)if they want less stock market concentration and technological exposure. However, over the past decade, the Vanguard S&P 500 Index has outperformed it.

One of the beauties of the S&P 500 is that as a market-weighted index, it allows its winners to become larger contributors to the index, while losing stocks become less important. In contrast, an equal-weighted index distributes its assets equally among its 500 securities by rebalancing them every quarter.

A JP Morgan study shows why the market-weighted approach performs better. It revealed that 40% of shares within the Russell 3000 Index between 1980 and 2020, they suffered what they call catastrophic losses, meaning losses of 70% or more from which they never recovered. Meanwhile, 10% of stocks were megawinners, outperforming the Russell 3000 by 500% or more during the period studied. It’s these megawinners who help drive market and index returns over time.

As such, I would continue to be long the Vanguard S&P 500 ETF. The ETF is a long-term winner, and while it currently has a higher concentration of tech stocks at the top, there’s a reason these companies have become the largest companies in the world. Technology continues to develop and change our lives and this will continue over time.