Careful, guarded optimism as economies slowly churn momentum
January 17, 2014 – VALLEY FORGE, Pa.–(BUSINESS WIRE)–In its recently published 2014 economic and investment outlook, Vanguard provides its long-term, global perspectives on the growth rates of the major world economies, inflation, interest rates, and stock and bond returns for the next ten years.
Highlight’s include a highlight on inflation, which suggests that “In the near term, monetary policies designed to achieve a desirable level of inflation will continue to counteract the deflationary pressures of a high-debt world still recovering from a deep financial crisis. Key drivers of U.S. consumer inflation generally point to higher-but-modest core inflation in the 1.5%–3% range over the next several years. In parts of Europe and in Japan, deflation remains a greater risk.”
Also, for investors looking to better allocate their money, the report underlines the importance of staying the course: Investors should expect less compensation for taking on additional risk than a few years ago. Vanguard’s simulations indicate that balanced portfolio returns over the next decade are likely to be below long-run historical averages, with those for a 60/40 stock/bond portfolio tending to fall in the 3%-5% range after inflation. Even so, Vanguard still firmly believes that a balanced and diversified low-cost portfolio can remain a high-value proposition in the decade ahead.
Here are highlights of the report:
- Global economy
For the first time since the financial crisis, Vanguard’s leading indicators point to a slight pick-up in near-term growth for the United States, parts of Europe, and other select developed markets. Continued progress in U.S. consumer deleveraging, strong corporate balance sheets, firmer global trade, and less fiscal drag point to U.S. growth approaching 3%. Those positives, however, need to be considered alongside high unemployment and government debt, ongoing structural reforms in Europe, China, and Japan, and extremely aggressive monetary policies whose exit strategies have yet to be tested. - Inflation
In the near term, monetary policies designed to achieve a desirable level of inflation will continue to counteract the deflationary pressures of a high-debt world still recovering from a deep financial crisis. Key drivers of U.S. consumer inflation generally point to higher-but-modest core inflation in the 1.5%–3% range over the next several years. In parts of Europe and in Japan, deflation remains a greater risk. - Monetary policy
Tapering in the Federal Reserve’s QE program has begun, although an actual tightening by the Fed is likely some time off. The federal funds rate appears likely to remain near 0% through mid-2015. That said, real (inflation-adjusted) short-term interest rates are likely to remain negative through perhaps 2017. Globally, the burdens on monetary policymakers are high as they contemplate extricating from QE policies to prevent asset bubbles on one hand and being mindful of raising short-term rates too aggressively on the other. The exit may induce market volatility at times, but long-term investors should prefer that to no exit at all. - Interest rates
The bond market continues to expect Treasury yields to rise, with a bias toward a steeper Treasury yield curve until the Federal Reserve raises short-term rates. Vanguard’s estimates of the fair value range for the 10-year Treasury bond have risen and suggest that the 10-year yield may range from 2.5%-3.5% over the next year. Vanguard believes that a more normalized environment, where rates move toward 5%, may be several years away. - Bond market
The return outlook for fixed income is muted, although it has improved somewhat given the recent rise in real rates. The expected long-run median return of the broad taxable U.S. fixed income market is in the 1.5%–3% range, versus the 0.5%-2% range this time last year. Nevertheless, the diversification benefits offered by fixed income in a balanced portfolio continue to be very important. Vanguard believes that the prospects of losses in bond portfolios should be weighed against the magnitude of potential losses in equity portfolios as the latter have tended to exhibit much larger swings in returns. - Global equity market
Vanguard’s medium-term outlook for global equities has become more guarded. In the 6%-9% return range, the long-term median nominal return for global equity markets is below historical averages, and has shifted toward the bottom of this range. In addition, concern over the reach for yield in bonds is now joined by signs of “froth” in certain segments of the global equity market. Vanguard therefore encourages investors to be cautious about increasing equity risk in the current environment. - Asset allocation strategies
Investors should expect less compensation for taking on additional risk than a few years ago. Vanguard’s simulations indicate that balanced portfolio returns over the next decade are likely to be below long-run historical averages, with those for a 60/40 stock/bond portfolio tending to fall in the 3%-5% range after inflation. Even so, Vanguard still firmly believes that a balanced and diversified low-cost portfolio can remain a high-value proposition in the decade ahead.
The asset-return distributions in the report represent Vanguard’s view on the potential range of risk premiums that may occur over the next ten years, and are not intended to be extrapolated into a short-term view. Potential outcomes for long-term investment returns are generated by the Vanguard Capital Markets Model®.
About VanguardVanguard, headquartered in Valley Forge, Pennsylvania, is one of the world’s largest investment management companies and a leading provider of company-sponsored retirement plan services. Vanguard manages more than $2.45 trillion in U.S. mutual fund assets, including more than $330 billion in ETF assets. The firm offers more than 160 funds to U.S. investors and more than 100 additional funds in non-U.S. markets. For more information, visit vanguard.com.
