2018 Economic and market outlook: Rising risks to the status quo

13 December 2017 | Markets and economy

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For 2018 and beyond, our investment outlook is modest, at best. Elevated valuations, low volatility, and secularly low interest rates are unlikely to be allies for robust financial market returns over the next five years. Downside risks are more elevated in the equity market than the bond market.

In this report, our Vanguard Investment Strategy Group outlines its expectations over the next decade for global economic growth, inflation, monetary policy, interest rates, and returns for stocks and bonds.

Our market outlook underscores the need for investors to remain disciplined and globally diversified, armed with reasonable return expectations and low-cost strategies.

Summary
Global outlook
Regional outlook
Investment outlook

1 The Group of Seven (G7) countries are the industrialized democracies Canada, France, Germany, Italy, Japan, the United Kingdom, and the United States.
Source: Vanguard, based on data from the International Monetary Fund.

2 Chart shows the percentage of Organization for Economic Co-operation and Development countries and China at full employment (GDP-weighted).
Source: Vanguard, using data from the OECD and the International Monetary Fund.

3 Source: Vanguard.

4 Chart depicts consumer and business sentiment indicators from the Vanguard Leading Economic Indicators Index, an aggregation of the signals of a proprietary set of leading economic indicators that is further filtered to include only sentiment and survey measures.
Source: Vanguard calculations, based on data from Moody's Analytics Data Buffet.

5 Source: Vanguard calculations, using data from Thomson Reuters Datastream.

6 Source: Vanguard calculations, using data from the People’s Bank of China and the National Bureau of Statistics of China.

7 Source: Eurobarometer.

8 Summary statistics of 10,000 Vanguard Capital Markets Model® (VCMM) simulations for projected ten-year annualized nominal returns are as of September 30, 2017, in U.S. dollars before costs. Historical returns are computed using indexes defined in “Indexes used in our historical calculations” on page 5 of the paper. The global equity portfolio is 60% U.S. equity and 40% global ex-U.S. equity. The international bond portfolio is 70% U.S. bonds and 30% global ex-U.S. bonds. Portfolios with tilts include a 20% tilt to the asset specified, funded from fixed income allocation for the fixed income tilt and equity allocation for the equity tilt. The optimized frontier consists of U.S. equity, non-U.S. equity, U.S. bonds, non-U.S. bonds, U.S. intermediate credit, Treasury Inflation-Protected Securities (TIPS) and long-term Treasury bonds. Non-U.S. equity is constrained to not exceed 60% of the equity allocation. Non-U.S. bonds are constrained to not exceed 50% of the bond allocation. Allocation to U.S. intermediate credit is constrained to not exceed 70% of the U.S. bond allocation.

IMPORTANT: The projections or 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. Distribution of return outcomes from the VCMM are derived from 10,000 simulations for each modeled asset class. Simulations are as of September 30, 2017. Results from the model may vary with each use and over time. For more information, see information below.
Source: Vanguard. © 2018 The Vanguard Group, Inc. All rights reserved.

9 Probability of success is defined as the probability of having a positive balance in a target-date fund at age 95, based on specific savings and spending assumptions. Data show the impact of each factor changing from low (25th percentile of broad population data) to medium (50th percentile). VCMM simulations are as of March 31, 2016. Investment cost is the relative impact on the probability of success of a target-date fund with a 50-basis-point higher fee or investment cost. For details, see the research paper Vanguard Life-Cycle Investing Model: A Framework for Building Target-Date Portfolios (2016).
Source: Vanguard.
IMPORTANT: The projections or other information generated by the Vanguard Capital Markets Model regarding the likelihood of various investment outcomes are hypothetical in nature, do not reflect actual investment results, and are not guarantees of future results. VCMM results will vary with each use and over time. The VCMM projections are based on a statistical analysis of historical data. Future returns may behave differently from the historical patterns captured in the VCMM. More important, the VCMM may be underestimating extreme negative scenarios unobserved in the historical period on which the model estimation is based. The VCMM is a proprietary financial simulation tool developed and maintained by Vanguard's Investment Strategy Group. The model forecasts distributions of future returns for a wide array of broad asset classes. Those asset classes include U.S. and international equity markets, several maturities of the U.S. Treasury and corporate fixed income markets, international fixed income markets, U.S. money markets, commodities, and certain alternative investment strategies.
The theoretical and empirical foundation for the Vanguard Capital Markets Model is that the returns of various asset classes reflect the compensation investors require for bearing different types of systematic risk (beta). At the core of the model are estimates of the dynamic statistical relationship between risk factors and asset returns, obtained from statistical analysis based on available monthly financial and economic data. Using a system of estimated equations, the model then applies a Monte Carlo simulation method to project the estimated interrelationships among risk factors and asset classes as well as uncertainty and randomness over time. The model generates a large set of simulated outcomes for each asset class over several time horizons. Forecasts are obtained by computing measures of central tendency in these simulations. Results produced by the tool will vary with each use and over time.

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