Insights on long-term expectations for stock returns and interest rates


Investors have been asking what’s ahead for the markets. Fran Kinniry of Vanguard Investment Strategy Group offers insights on Vanguard’s long-term expectations for stock returns and interest rates.


Notes:

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.
Investments in stocks or bonds issued by non-U.S. companies are subject to risks including country/regional risk and currency risk. These risks are especially high in emerging markets.

Bond funds are subject to the risk that an issuer will fail to make payments on time, and that bond prices will decline because of rising interest rates or negative perceptions of an issuer’s ability to make payments.

All investing is subject to risk, including the possible loss of the money you invest. Diversification does not ensure a profit or protect against a loss.

This webcast is for educational purposes only. We recommend that you consult a tax or financial advisor about your individual situation.

© 2017 The Vanguard Group, Inc. All rights reserved.


TRANSCRIPT

Amy Chain: We’re going to take a question that’s come in from Richard, and I’m sure you’re answering this on the road quite a bit. “Over the next ten years, what are your expected returns for U.S. stocks, European stocks, emerging market stocks, the whole gambit.” Let’s talk about expectations.

Fran Kinniry:
Yes, so let’s start with equities. You know I think back to the question of irrational exuberance and where the equity market’s at. They’re certainly not at levels that we saw in 1999 when the first term came out towards the end of the internet tech bubble. But let’s be clear. Equity valuations are high. They’re in their top 15, 20% of historical valuations depending on the metric you look at. So when we would say equities, we would say our long-run returns, a ten-year return forecast is about 1 to 2% below its historical returns.

So let’s say 7 or 8%. But I want to be real careful on the caveat there. Even at 7 or 8%, there’s a wide distribution of returns even from our outlook from the Vanguard Capital Markets Model*; Joe Davis, who I work with very closely, it still has a very wide distribution.

*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 the VCMM are derived from 10,000 simulations for each modeled asset class. Simulations are as of January 31, 2017. Results from the model may vary with each use and over time. In fact, 25% of our observations have double-digit returns, more than 10, and another 20, 25% below 2%. So while people may focus on the 7 or 8 number, it’s a wide distribution. International and emerging markets carry higher risk to them, they’ve historically carried higher risk, and so higher risk should have slightly higher returns. And you get compensated for higher risks, so it’s a slightly higher returns on non-U.S. and emerging. But risk-adjusted, probably back to being similar. Bonds, no doubt. Low interest rates. We’re sitting here today at let’s say 2½% interest rates. I would caution everyone about that interest rates have to rise. I know that’s been the feeling, but it’s been the feeling for 15 years. Really dating back to 2002. And so 2.5, 2.4%, and then if you look at where U.S. rates are, relative to the world, 2.4 or 2.5 in the U.S., given its credit quality, ability to repay, looks like a pretty darn good bargain relative to most of Europe, which is somewhere around zero and others. Take it to the high-net-worth crowd of tax-exempt, municipal bonds. After-tax-equivalent. So I would not necessarily, well, bonds do not look with a big smile, they certainly have properties of diversification and the yields look attract relative to their risks.

Important information

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 amongrisk 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.

Investments in stocks or bonds issued by non-U.S. companies are subject to risks including country/regional risk and currency risk. These risks are especially high in emerging markets.

Bond funds are subject to the risk that an issuer will fail to make payments on time, and that bond prices will decline because of rising interest rates or negative perceptions of an issuer’s ability to make payments.

All investing is subject to risk, including the possible loss of the money you invest. Diversification does not ensure a profit or protect against a loss.

This webcast is for educational purposes only. We recommend that you consult a tax or financial advisor about your individual situation.

© 2017 The Vanguard Group, Inc. All rights reserved.