This post has been updated with comments from Roger Aliaga Diaz, Americas Chief Economist for Vanguard.
Vanguard released it’s 2017 Economic and Market Outlook on Monday which would appear to be contradictory at first glance, but is actually “nuanced” in reporting continued low growth and low rates while rejecting the “persistent myth of economic stagnation,” according to the company.
“We’re opposed to the view put forth by people like [former Treasury Secretary] Larry Summers that we’re experiencing economic stagnation that requires extreme policy prescriptions to fix,” Diaz said. “At the same time, we see low but sustainable growth moving forward.”
The Pennsylvania-based investment behemoth, with $3.8 trillion in assets, blames “secular forces” for tempered growth, driven by “the seminal themes of globalization, the demographic headwinds of an aging global workforce, and rapid advances in technology,” before adding it believes the world is nonetheless “adjusting to the disruption of structural deceleration.”
“The secular drivers to which we refer wouldn’t be boosted much by extreme stimulus of the type some are calling for anyway,” Diaz added. “Yes, growth is low, but not flat. Flat is not something you see when economies are at full employment, which we essentially are at now.”
Amidst persistent global weakness, the U.S. economy remains resilient, the Outlook explains. The U.S. economy has been expanding for seven years—more than double the average length of an expansion—and Vanguard economists expect a continued long-term growth path of about 2 percent per year.
Yet, researchers acknowledge that this abnormally long period of growth is not without tail risks, and markets will remain highly sensitive to unexpected shocks.
The policy direction of the new administration, along with the associated uncertainty, will prove meaningful over the long term. In particular, the rollout of fiscal and trade policies have significant implications for the global economic environment.
More expansionary domestic policies, such as tax cuts and infrastructure spending, along with an unforeseen flare-up in inflationary pressures, could potentially trigger the acceleration of interest rates. In addition to policy drivers, international influences, such as the breakdown of Brexit negotiations or global spillovers from emerging market volatility, have the potential to dislocate the current expansion.
With these global and domestic challenges as backdrop, Vanguard’s outlook for global stocks and bonds is the most guarded it has been in 10 years. The expected ten-year median return of the global fixed income market is centered in the 1.5-2.5 percent range, resembling the historical bond returns of the 1950s and 1960s. Vanguard forecasts show that the median outlook for global equities is in the 5-7 percent range, significant departure from returns experienced since the market bottomed in March of 2009.
Signals and noise: Avoid the lure of short-termism
Vanguard’s probabilistic framework for forecasting can provide meaningful context for market movements, alarming headlines, and continuous uncertainty. Most importantly, this economic and investment analysis reinforces the need for a long-term perspective and goals-based approach to portfolio construction.
In anticipation of compressed return opportunities, investors may be enticed to implement portfolio strategies dependent on market conditions or economic projections. To underscore the risks of this approach, Vanguard economists conducted an examination of portfolio strategies designed to perform in low-yield, high-yield, and expected-yield scenarios.
Conclusively, portfolios designed for a single scenario have narrow upside, coupled with large margins of error. Vanguard’s analysis illustrates that a diversified portfolio performs best for investors who do not have a strong conviction about the future state of the economy, meaning it exhibits better downside outcomes relative to long-duration or short-duration strategies.
“Given our outlook for 2017 and beyond, some investors might be tempted to add new asset classes or apply portfolio tilts in search for alpha in a low-growth world, which could expose them to undue risk and potentially erode their assets over time,” said Vanguard CEO Bill McNabb. “Now, perhaps more than ever, investors will benefit most in the long run by increasing their savings contributions, reducing their investment costs, and maintaining a thoughtful asset allocation course to reach their goals.”
Vanguard’s global market outlook points to a more challenging environment ahead, yet one in which investors with an appropriate level of discipline, diversification, and patience are likely to be rewarded over the next decade with fair inflation-adjusted returns.
With more than 20 years serving financial markets, John Sullivan is the former editor-in-chief of Investment Advisor magazine and retirement editor of ThinkAdvisor.com. Sullivan is also the former editor of Boomer Market Advisor and Bank Advisor magazines, and has a background in the insurance and investment industries in addition to his journalism roots.