16 June 2019

Vanguard 2014 Economic And Investment Outlook

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According to Vanguard, the 2014 outlook for Global Equities will be in the 6% to 9% range. The median is moderately below the historical average and revised downward from this time last year, mainly because of current market valuations and their implications for the equity risk premium.  Vanguard’s outlook is informed by valuation metrics (such as price/earnings ratios) that relate accounting measures of value to the market’s aggregate price. Valuations today are elevated in relation to both their lows in 2009 and their historical averages.

Vanguard believes that valuations will revert to a long-term average level and this reversion has been the largest driver of the movement of long-term equity returns over time. This supports their long-held view that valuations, not growth, are the most significant drivers of returns. Therefore, valuations are the most useful metric in estimating forward-looking expected returns of equity markets.

But what level will valuations revert? Most valuation metrics have been above their long-term averages for more than two decades, raising questions about the potential for structural shifts. Without certainty as to where exactly valuations will move in the future, it is very difficult to pin down a precise estimate of the equity risk premium.

In short, although there is evidence of froth in global equity markets it is hard to identify a bubble. The uncertainty associated with forward-looking return estimates underscores the fact that today’s valuation levels present a range of potential outcomes. However, because the premium compensating increased equity risk appears to have fallen recently, Vanguard is encouraging investors to exercise caution in making strategic or tactical portfolio changes that increase this risk.

Specifically, Vanguard’s valuation simulations indicate that the average annualized returns of a 60% equity/40% bond portfolio for the decade ending 2023 are expected to center in the 3.1% to 5.2% real return range, below the actual average real return of 5.5% for the same portfolio since 1926.

Click here to read the entire analysis from Vanguard. 

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