July 29, 2020 | Vanguard Perspective
2020 midyear economic highlights
The world's economies have only now started to recover from the COVID-19 pandemic. The risks around our forecast relate mainly to health outcomes and are skewed to the downside. In addition, considerable uncertainty remains, with further market corrections possible. We expect that:
- The recovery will be protracted and slow, with GDP growth not returning to normal until well into 2021.
- Over the next ten years the average returns will be between 4% and 6% for U.S. equities and between 7% and 9% for international equities.
- Fixed income returns in the U.S. and abroad will remain muted, but bonds are still an important risk diversifier in a multi-asset portfolio.
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. Distribution of return outcomes from the VCMM are derived from 10,000 simulations for each modeled asset class. Simulations are as of June 30, 2020. Results from the model may vary with each use and over time. For more information, please see the notes section.
Baseline forecast, upside surprises, and downside risks
Our baseline scenario is one in which global economies are regularly dealing with sporadic virus "flare-ups."
- We do not expect GDP growth to return to normal until well into 2021 and quite possibly beyond. And even then we expect some "scarring" as a result of permanent job losses, bankrupted businesses, and the costs of possible reallocation of resources.
- We expect monetary policy to remain at its current loose setting well into next year.
- Given the slow and protracted recovery, we expect aggregate inflation measures to remain low.
Health developments are the biggest risk factors defining the recovery
Projected 10-year returns
We expect that international equity returns will be a bright spot over the next 10 years.
- We expect the average return to be between 4% and 6% for U.S. equities and between 7% and 9% for international equities.
- A second wave of infection might drive equity returns down or the discovery of a vaccine could boost market sentiment.
- We expect that global fixed income yields will remain low (between 0% and 2%) given accommodative monetary policy in the U.S. and internationally. But bonds remain an important diversifier in portfolios.
Equity markets’ prospects have improved since the market correction. Fixed income expected returns remain subdued.
Assessing the recovery
Look for the first phase to show rapid signs of recovery as businesses reopen and restrictions are eased.
- The second phase is likely to take longer as demand, especially in sensitive face-to-face sectors, only gradually returns.
- Only in China is the recovery expected to be faster and more V-shaped.
How soon will major economies recover?
How economic sectors stack up
The impact of the virus, along with the containment measures, affects each economic sector differently.
- Sectors that are highly reliant on face-to-face interactions, such as retail trade, hospitality, and transport, experience a large shock to activity.
- Sectors that can operate relatively well with social distancing in place, such as construction and manufacturing, are less affected.
What's ahead for growth?
Global growth is expected to move into negative territory by 3% in 2020, the first time in modern economic history.
- Europe and the U.K. show the largest annual falls of around 10%, with the U.S. not much smaller.
- In China, where the virus was better contained, growth is only expected to fall to 2%, very low by Chinese standards.
How the pandemic shaped GDP projections
- IMPORTANT: The projections and 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 Vanguard Capital Markets Model is a proprietary financial simulation tool developed and maintained by Vanguard’s primary investment research and advice teams. 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 from as early as 1960. 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.
The long-term returns of our hypothetical portfolios are based on data for the appropriate market indexes through June 2020. We chose these benchmarks to provide the most complete history possible, and we apportioned the global allocations to align with Vanguard’s guidance in constructing diversified portfolios. Asset classes and their representative forecast indexes are as follows:
- U.S. equities: MSCI US Broad Market Index.
- Global ex-U.S. equities: MSCI All Country World ex USA Index.
- U.S. REITs: FTSE/NAREIT US Real Estate Index.
- U.S. cash: U.S. 3-Month Treasury—constant maturity.
- U.S. Treasury bonds: Bloomberg Barclays U.S. Treasury Index.
- U.S. short-term Treasury bonds: Bloomberg Barclays U.S. 1–5 Year Treasury Bond Index.
- U.S. long-term Treasury bonds: Bloomberg Barclays U.S. Long Treasury Bond Index.
- U.S. credit bonds: Bloomberg Barclays U.S. Credit Bond Index.
- U.S. short-term credit bonds: Bloomberg Barclays U.S. 1–3 Year Credit Bond Index.
- U.S. high-yield corporate bonds: Bloomberg Barclays U.S. Corporate High Yield Bond Index.
- U.S. bonds: Bloomberg Barclays U.S. Aggregate Bond Index.
- Global ex-U.S. bonds: Bloomberg Barclays Global Aggregate ex-USD Index.
- U.S. TIPS: Bloomberg Barclays U.S. Treasury Inflation Protected Securities Index.
- U.S. short-term TIPS: Bloomberg Barclays U.S. 1–5 Year Treasury Inflation Protected Securities Index.
Notes on risk
All investing is subject to risk, including the possible loss of the money you invest. Past performance is no guarantee of future returns. Investments in bond funds are subject to interest rate, credit, and inflation risk. Foreign investing involves additional risks, including currency fluctuations and political uncertainty. Diversification does not ensure a profit or protect against a loss in a declining market. There is no guarantee that any particular asset allocation or mix of funds will meet your investment objectives or provide you with a given level of income. The performance of an index is not an exact representation of any particular investment, as you cannot invest directly in an index.
Stocks of companies in emerging markets are generally more risky than stocks of companies in developed countries. U.S. government backing of Treasury or agency securities applies only to the underlying securities and does not prevent price fluctuations. Investments that concentrate on a relatively narrow market sector face the risk of higher price volatility. Investments in stocks issued by non-U.S. companies are subject to risks including country/regional risk and currency risk.
Bond funds are subject to the risk that an issuer will fail to make payments on time, and that bond prices will decline because of rising interest rates or negative perceptions of an issuer’s ability to make payments. High-yield bonds generally have medium- and lower-range credit-quality ratings and are therefore subject to a higher level of credit risk than bonds with higher credit-quality ratings. Although the income from U.S. Treasury obligations held in the fund is subject to federal income tax, some or all of that income may be exempt from state and local taxes.