Commentary by Joseph H. Davis, Ph.D., Vanguard global chief economist

Why should long-term investors care about market forecasts? Vanguard, after all, has long counselled investors to set a strategy based on their investment goals and to stick to it, tuning out the noise along the way.

The answer, in short, is that market conditions change, sometimes with long-term implications. Tuning out the day-to-day noise from investment markets remains important to help avoid impulsive and suboptimal decisions. Occasionally reassessing investment strategies to ensure that they rest upon reasonable expectations is also important. It wouldn’t be reasonable, for example, for an investor to expect a 5% annual return from a bond portfolio, which is around the historical average, in our current low-rate environment.

“Treat history with the respect it deserves,” the late Vanguard founder John C. “Jack” Bogle said. “Neither too much nor too little.”1

Our Vanguard Capital Markets Model® (VCMM), the rigorous and thoughtful forecasting framework that we’ve honed over the years, suggests that investors should prepare for a decade of returns below historical averages for both stocks and bonds.

The value of market forecasts rests on reasonable expectations

At Vanguard, we believe the role of a forecast is to set reasonable expectations for uncertain outcomes upon which current decisions depend. In practical terms, VCMM projections inform our portfolio construction process and we hope the forecasts help our adviser partners set reasonable expectations for their clients.

Short of a silver bullet, we believe that a good forecast objectively considers the broadest range of possible outcomes, clearly accounts for uncertainty and complements a rigorous framework that allows for our views to be updated as facts bear out.

When estimating future asset returns, relying purely on historical averages might be a flawed guide of what lies ahead. VCMM is instead a forward-looking, global tool that studies the past, including why markets behaved as they did, as well as using current economic and financial conditions to set expectations for risk and return of more than 300 asset classes over the medium and long-term. 

So how have our market forecasts fared, and what lessons do they offer?

Some lessons from our forecasts

market forecasts

Notes: The figures show the forecast and realised 10-year annualised returns for a 60% stock/40% bond portfolio, for US equities and for ex-US equities (all US dollar-denominated). On each figure, the last point on the darker line is the actual annualised return from the 10 years beginning 1 October 2010, and ended 30 September 2020, and covers the same period as the Vanguard Capital Markets Model (VCMM) forecast as at 30 September 2010. The last points on the dashed line and the surrounding shaded area are our forecasts for annualised returns at the 25th, 50th (median), and 75th percentiles of VCMM distributions as at 31 July 2021, for the 10 years ending 31 July 2031. VCMM simulations use the MSCI US Broad Market Index for US equities, the MSCI All Country World ex USA Index for global ex-US equities, the Bloomberg U.S. Aggregate Bond Index for US bonds, and the Bloomberg Global Aggregate ex-USD Index for ex-US bonds. The 60/40 portfolio consists of 36% US equities, 24% global ex-US equities, 28% US bonds and 12% ex-US bonds.

Source: Vanguard calculations, using data from MSCI and Bloomberg.

Past performance is no guarantee of future returns. The performance of an index is not an exact representation of any particular investment, as you cannot invest directly in an index.

IMPORTANT: The projections and other information generated by the Vanguard Capital Markets Model® (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. The distribution of return outcomes from the VCMM is derived from 10,000 simulations for each modeled asset class. Simulations for previous forecasts were as of 30 September 2010. Simulations for current forecasts are as of 31 July 2021. Results from the model may vary with each use and over time. For more information, please see important information below.

The illustration above shows that 10-year annualised returns for a portfolio containing 60% equities and 40% bonds over the last decade largely fell within our set of expectations, as informed by the VCMM. Returns for US equities surpassed our expectations, while returns for ex-US equities were lower than we had expected.

The data reinforces our belief in balance and diversification, as discussed in Vanguard’s Principles for Investing Success. We believe that investors should hold a mix of stocks and bonds that is appropriate according to their goals and should diversify these assets broadly across global markets.

You may notice that our long-term forecasts for a diversified 60/40 portfolio haven’t been static over the past decade, nor have the 60/40 market returns. Both our expectations and actual returns rose toward the end of the decade, ten years after markets hit the bottom in the wake of the global financial crisis of 2007/08. Our framework recognised that although economic and financial conditions were poor during the crisis, future returns could be stronger than average. In that sense, our forecasts were appropriate in tuning out the doom and gloom of the period and focusing on what was reasonable to expect.

Our outlook then became one of cautious optimism, a forecast that proved fairly accurate. Today, financial conditions are relatively loose – some might even say exuberant. Our framework forecasts softer returns based on today’s ultra-low interest rates and elevated equity valuations in the US – the world’s leading stock market. That can have important implications for how much investors save and what they expect to earn on their investments.

What to expect in the decade ahead

Our latest forecasts tell us that investors shouldn’t expect the next decade to look like the past ten years, and advisers need to plan strategically to overcome a low-return environment. Knowing this, clients may plan to save more, reduce expenses, delay goals (perhaps including retirement) or adjust the ratio of bonds and equities in their portfolio where appropriate.

And they may be wise to recall something else Jack Bogle said: “Through all history, investments have been subject to a sort of Law of Gravity: What goes up must go down, and, oddly enough, what goes down must go up.”2

 

1 Bogle, John C., 2015. Bogle on Mutual Funds: New Perspectives for the Intelligent Investor. Hoboken, N.J.: John Wiley & Sons, Inc.

2 Jenks, Philip, and Stephen Eckett, 2002. The Global-Investor Book of Investing Rules: Invaluable Advice from 150 Master Investors. Upper Saddle River, N.J.: Prentice Hall PTR.

Additional contributions by Ian Kresnak, CFA

Investment risk information

The value of investments, and the income from them, may fall or rise and investors may get back less than they invested.

Important information

For professional investors only (as defined under the MiFID II Directive) investing for their own account (including management companies (fund of funds) and professional clients investing on behalf of their discretionary clients). In Switzerland for professional investors only. Not to be distributed to the public.

The information contained in this document is not to be regarded as an offer to buy or sell or the solicitation of any offer to buy or sell securities in any jurisdiction where such an offer or solicitation is against the law, or to anyone to whom it is unlawful to make such an offer or solicitation, or if the person making the offer or solicitation is not qualified to do so. The information in this document does not constitute legal, tax, or investment advice. You must not, therefore, rely on the content of this document when making any investment decisions.

Issued in EEA by Vanguard Group (Ireland) Limited which is regulated in Ireland by the Central Bank of Ireland.

Issued in Switzerland by Vanguard Investments Switzerland GmbH.

Issued by Vanguard Asset Management, Limited which is authorised and regulated in the UK by the Financial Conduct Authority.

© 2021 Vanguard Group (Ireland) Limited. All rights reserved.

© 2021 Vanguard Investments Switzerland GmbH. All rights reserved.

© 2021 Vanguard Asset Management, Limited. All rights reserved.