VALLEY FORGE, PA (January 16, 2014)—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.
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®.
IMPORTANT: The projections or other information generated by the VCMM regarding the likelihood of various investment outcomes are hypothetical in nature, do not reflect actual investment results, and are not guarantees of future results. Distribution of return outcomes from VCMM, derived from 10,000 simulations for U.S. equity returns and fixed income returns. Simulations as of November 30, 2013. Results from the model may vary with each use and over time.
IMPORTANT: The projections or other information generated by the Vanguard Capital Markets Model regarding the likelihood of various investment outcomes are hypothetical in nature, do not reflect actual investment results, and are not guarantees of future results. VCMM results will vary with each use and over time.
The VCMM projections are based on a statistical analysis of historical data. Future returns may behave differently from the historical patterns captured in the VCMM. More important, the VCMM may be underestimating extreme negative scenarios unobserved in the historical period on which the model estimation is based.
The Vanguard Capital Markets Model® is a proprietary financial simulation tool developed and maintained by Vanguard’s primary investment research and advice teams. The model forecasts distributions of future returns for a wide array of broad asset classes. Those asset classes include U.S. and international equity markets, several maturities of the U.S. Treasury and corporate fixed income markets, international fixed income markets, U.S. money markets, commodities, and certain alternative investment strategies. The theoretical and empirical foundation for the Vanguard Capital Markets Model is that the returns of various asset classes reflect the compensation investors require for bearing different types of systematic risk (beta). At the core of the model are estimates of the dynamic statistical relationship between risk factors and asset returns, obtained from statistical analysis based on available monthly financial and economic data from as early as 1960. Using a system of estimated equations, the model then applies a Monte Carlo simulation method to project the estimated interrelationships among risk factors and asset classes as well as uncertainty and randomness over time. The model generates a large set of simulated outcomes for each asset class over several time horizons. Forecasts are obtained by computing measures of central tendency in these simulations. Results produced by the tool will vary with each use and over time.
Vanguard, 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.
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All asset figures are as of December 31, 2013, unless otherwise noted.
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