We’re in one of the longest bull markets of all time, following one of the worst economic recessions of all time. However, this economic recovery has also been one of the slowest of all time.
Since the global financial crisis, the global recovery has continued to be very modest and – at times – frustratingly fragile. In the United States, for example, the economy has grown at an average annual rate of about 2.00%, whereas growth since 1950 has averaged an annual rate of 3.25%.
Based on market and economic conditions, Vanguard’s outlook for the equity and fixed income markets is the most guarded it has been in ten years.
How technology, demographics, and globalization are restraining global growth;
What that means for expected returns over the next decade;
How different portfolios are expected to fare under different economic scenarios.
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1. What are the structural forces dampening global growth and interest rates?
Technological disruption, unfavorable demographics, and expanding globalization – forces at work since the 1980s – are likely to keep growth and interest rates low by historical standards. Below are examples of what these structural forces look like in everyday life:
Technology: Falling technology costs are reducing the amounts businesses are spending on capital. An economy with fewer factories and brick-and-mortar stores, but more apps and online spending, can lead to lower capital spending.
Demographics: Aging populations are weighing on growth in the developed world. Economies with younger populations buy more consumer goods, whereas old populations spend less and save more, which can produce a a savings glut.
Globalization: The free movement of capital and products is increasing competition on prices and labor. Increased trade makes use of comparative advantages in production, which translates into cheaper labor and cheaper goods. The end result? Lower inflation.
Together, these structural forces have contributed to the current economic environment of historically low growth and interest rates and will continue to do so in the years ahead.
2. What are the implications for your returns over the next decade?
Vanguard’s outlook for global stocks and bonds remains the most guarded it has been in ten years, given that interest rates are unlikely to rise substantially and that current valuations are stretched.
Expected return ranges are:
Fixed Income: 1.5%-2.5% (“Positive but muted”) compared to average global bond returns of 5.4% in 1926-2016.
Equity: 5%-8% (“Still guarded, but not bearish”) compared to average global stock returns of 10.0% in 1926-2016.
3. How would different portfolio construction strategies fare in various economic scenarios?
Given Vanguard’s global outlook, the charts below examine three yield-curve scenarios over the next five years and the effectiveness of various portfolio strategies designed for specific scenarios.
A long duration portfolio (60% long-term Treasury index, 30% U.S. equity, and 10% global equities and bonds) performed best in a low-yield scenario.
A 60/40 diversified portfolio (60% diversified equity, 40% diversified bonds) performed best in a moderate-yield scenario.
A short duration portfolio (60% diversified equity, 40% bonds skewed toward short-term credit) performed best in a high-yield scenario.
The key takeaways here are that (1) portfolios designed for extreme scenarios involve important trade-offs, and (2) the diversified portfolio works best for investors who do not have a strong conviction about the future state of the economy.