On Jan. 31, Vanguard released its outlook for U.S. economic growth, inflation, interest rates, and returns for stocks and bonds in the decade ahead. It highlighted the following points:
U.S. economic recovery should continue to grow at a below-average 2-3% pace, and future U.S. economic growth could prove uneven, “marked by periodic bouts of market volatility and economic slowdowns in 2012 and beyond.”
An “inflation paradox” should stay in place for much of the developed world, as central banks grapple with the need to mitigate the deflationary forces of debt reduction and fiscal austerity with concerns over higher-than-expected inflation in the future.
U.S. inflation should be “better behaved” and average in the 2-3% range over the next several years, as the risk of high inflation is estimated at less than 10%.
Real (inflation-adjusted) interest rates are likely to remain negative for years.
The return outlook for broad bond portfolios is muted, though the diversification benefits of bonds should persist despite the tendency for slightly higher interest rates over the next decade.
The long-run outlook for the global stock market is likely to be attractive despite elevated market volatility, below-average growth expectations and near-zero short-term interest rates.
The report concludes: “Balanced-portfolio returns over the next decade have a higher chance of matching their long-run averages than some may think, especially when those returns are adjusted for our outlook of future inflation. In short, the distribution of real returns on a balanced portfolio looks more normal than abnormal.”
Vanguard adds that, contrary to some suggestions that the next decade warrants a radically new investment strategy, the fund giant is sticking with its long-held view and its principles of portfolio construction remain unchanged, given the expected risk-return trade-off among stocks and bonds.
“Vanguard remains concerned that the volatile environment may lead some investors to retreat from their strategic allocations, while the low-yield environment may lead others to aggressively pursue higher portfolio returns under the allure of higher yields (potentially underestimating the associated risks), higher economic growth (without considering market valuations), or alternative investments (without regard to cost or risk exposure),” said chief economist Joe Davis, in a statement. “Again, Vanguard believes that a balanced and diversified low-cost portfolio remains crucial for the decade ahead.”