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• Optimistic forecasters say they expect high returns in 2026 because earnings are growing, but the truth is that P/Es are the main driver, not earnings growth.
• A contraction in P/E below the current 30 will result in losses, regardless of earnings growth, that could exceed 60%.
• Baby boomers should protect their lifetime savings now because they are in the Retirement Risk Zone.

Return forecasts for 2026 are based on P/E multiples remaining near current all-time highs of 30. Remember Stein’s Law: If something cannot go on forever, it will end.

It’s that time of year again when pundits tell us what the stock market will return. Most use intuition and optimism rather than math. Math turns assumptions into forecasts, and you can also look up a forecast to see the implied underlying assumptions.

 Here’s the formula for forecasting returns:

Return = Dividend Yield + (1 + Earnings Growth) X (1 + P/E expansion/contraction) – 1

And here’s a table that uses the formula to calculate returns for various levels of earnings growth and future P/E. Dividend yield is estimated at 1%.

Estimated Returns (%)

Source: Target Date Solutions

Most current forecasts have the stock market earning positive returns that appear in the bottom 2 rows of the table, revealing that the key assumption is that P/Es will not contract below 30, from the current 31. Most say that they’re optimistic because they expect significant earnings growth, say around 20%, but that logic only holds if P/Es don’t contract below 30; in other words, earnings growth is not the key – P/Es are the key.

If P/Es contract below the current level of 31, as many think they will, stock prices will plummet, perhaps as low as a 62% loss. I guess P/Es could increase, say to 35, but then very simple math predicts that future returns will decrease, as evidenced in the following:

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