What to look for in 2017
12 December 2016 | Markets and Economy
Leo Schulz (senior writer, Vanguard Asset Management): What to look for in 2017. What will be the big themes for investors in 2017? The Vanguard economic and investment outlook 2017 is out now, and I have with me two of the people who helped to write it. Peter, the key note this year is low growth but not stagnation. Could you just talk us through what lies behind that sound bite?
Peter Westaway (chief economist, Vanguard Europe): Sure. I mean, there are a lot of commentators out there that are worried that the global growth environment has completely stagnated so that we're in what's called secular stagnation. We're never going to get away from near-zero growth. We're not as pessimistic as that, but we do think that there's been a structural slowdown in growth.
Leo Schulz: So what are some of those structural issues, Peter?
Peter Westaway: Well, there's two or three, really. First of all, demographic forces are such that population growth is just lower, so that tends to lower growth. Secondly, productivity growth has never really picked up since the financial crisis. So that contribution to growth is also lower. And then thirdly, relative to the pre-crisis trends in growth that we used to see, we're not getting as much growth being generated by borrowing, by leverage. We think there's much less leverage in future, and that will also tend to push down on growth rates.
Leo Schulz: So, Peter, what will be the outcome for interest rates in this environment?
Peter Westaway: Well, one of the consequences of this is that interest rates around the world will tend to settle down at a lower level than they have done in the past. So for example, you think about here in the UK, in the past we used to be used to a number like 5% for interest rates. Probably now it's going to be somewhere nearer 3%, 2½% even – so, a much lower level.
Leo Schulz: So, quite a bit lower. Alexis, what will this mean for investment returns?
Alexis Gray (Vanguard economist): Well, as Peter mentioned, we expect real interest rates to be lower than where they've been historically, although picking up a little bit in the next several years. So from the point of view of a bond investor, that means that there's a fairly muted return outlook. We would anticipate that over a 10-year stretch each year your total return would be on average, let's say a median of 1% to 2%.
Leo Schulz: "Total return" meaning both income and capital growth.
Alexis Gray: That's right, exactly. And for equity returns we see a median of 6% to 8%. So, slightly lower than where we've seen historically. But I think given that we've got such low interest rates, in fact the UK equity market we would say at the moment may even be undervalued rather than overvalued.
Leo Schulz: And that's because a difference between a 6% to 7% return on equities is still quite good relative to interest rates if they're going to be around 2% to 3%.
Alexis Gray: Exactly.
Leo Schulz: Peter, what's that difference between bond returns and equity returns? A sensible investor surely would be moving their portfolio out of bonds and into equities.
Peter Westaway: No, I don't necessarily think so. I think there's still a really strong case for investors to maintain their portfolio, which would both be balanced and globally diversified. So that means that they should continue to hold equities to generate those long-run returns, but also continuing to hold bonds to provide that stability, and also to act as a counterweight to equities, so that when equities go up bonds will go down, and vice versa.
Leo Schulz: Lower growth, interest rates rising but still low. Long-run investment returns will reflect this lower rate of change. Peter Westaway, Alexis Gray, thank you both very much.
Peter Westaway: Thank you.
Alexis Gray: Thank you.
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