Market perspectives: February 2021

January 28, 2021 | Vanguard Perspective

Market perspectives: February 2021

Key highlights

  • The vaccination rollout reaffirms our outlook for U.S. GDP growth above 5% in 2021.
  • Vanguard's outlook for U.S. monetary policy remains dovish even amid discussions around additional fiscal stimulus. 
  • Vanguard doesn't foresee a prolonged period of job losses.
  • We expect some inflation volatility in the near-to-medium term but anticipate inflation will trend lower in the second half of the year.

Asset class return outlooks

Our 10-year, annualized, nominal return projections, as of September 30, 2020, are shown below. Please note that the figures are based on a 1.0-point range around the rounded 50th percentile of the distribution of return outcomes for equities and a 0.5-point range around the rounded 50th percentile for fixed income.

Equities Return projection Median volatility
U.S. equities 3.7%–5.7% 16.9%
U.S. value 4.8%–6.8% 18.7%
U.S. growth 1.1%–3.1% 18.1%
U.S. large-cap 3.6%–5.6% 16.5%
U.S. small-cap 3.7%–5.7% 21.6%
U.S. real estate investment trusts 3.3%–5.3% 19.5%

Global equities ex-U.S. (unhedged)

7.0%–9.0% 18.6%
     
Fixed income Return projection Median volatility
U.S. aggregate bonds 0.7%–1.7% 4.0%
U.S. Treasury bonds 0.3%–1.3% 4.1%
U.S. credit bonds 1.3%–2.3% 5.6%
U.S. high-yield corporate bonds 2.7%–3.7% 10.3%
U.S. Treasury Inflation-Protected Securities 0.4%–1.4% 6.3%
U.S. cash 0.6%–1.6% 0.9%
Global bonds ex-U.S. (hedged) 0.5%–1.5% 2.4%
Emerging markets sovereign 2.3%–3.3% 10.5%
U.S. inflation 0.9%–1.9% 2.4%

These probabilistic return assumptions depend on current market conditions and, as such, may change over time.

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. Distribution of return outcomes from the VCMM are derived from 10,000 simulations for each modeled asset class. Simulations are as of September 30, 2020. Results from the model may vary with each use and over time. For more information, see the Notes section.

Source: Vanguard Investment Strategy Group.

Economic growth picture is mixed

United States

Early-winter growth in COVID-19 cases hasn’t materially changed Vanguard's assessment of economic prospects in the United States since publication of our 2021 economic outlook, though we’re closely watching the timetable for vaccine rollout.

  • In fact, despite an initially slow rollout, a more recent trend of daily vaccinations approaching 1 million reaffirms our outlook for GDP growth above 5% in 2021.
  • Additional fiscal stimulus would introduce the potential for further upside to growth. Vanguard foresees fourth-quarter 2020 growth in the mid-to-high single digits, with high-frequency data supporting our view that the number could come in at the higher end.

Euro area

A surge in COVID-19 cases and resulting restrictions on economic activity has led Vanguard to temper our forecast for 2021 GDP in the euro area. We now expect the euro area economy to grow around 4.5% in 2021, lower than our 2021 forecast for growth around 5%.

China

The economy in China grew by 2.3% in 2020, according to China's National Bureau of Statistics, the only full-year growth that any major economy is likely to register for the year.

  • Vanguard maintains its forecast for China's economy to grow around 9% in 2021 as elevated developed-market demand for goods persists through the first half, particularly with additional fiscal stimulus likely in the United States, and as China’s domestic service sectors continue to recover.

Emerging markets

Vanguard foresees 2021 economic growth around 6% for emerging markets as effects of the pandemic and progress of vaccine rollout—sure to lag behind that of developed markets—remain central themes.

  • The outlook for Latin America, under assault from COVID-19, is particularly pessimistic.
  • Emerging markets will be watching developments in U.S.-China relations, which have implications for supply chains and trade-related growth.

Employment should improve in the U.S.

Vanguard doesn't foresee a prolonged period of job losses, with a return to job growth perhaps as early as January and average monthly job creation around 250,000 for all of 2021.

  • Recent job losses were most prominent in the leisure and hospitality sectors amid renewed lockdown measures as virus cases surge.

No major changes likely for the Fed

Given our expectation for a slow recovery in demand amid pandemic containment efforts, Vanguard continues to expect monetary policy to remain loose into 2021, with risks skewed toward further easing.

  • Vanguard's outlook for U.S. monetary policy remains dovish even amid discussions around additional fiscal stimulus to counter effects of the COVID-19 pandemic.
  • The Federal Reserve said its accommodative stance would continue "until substantial further progress has been made toward the Committee's maximum employment and price stability goals."
  • Tapering of its bond-buying program is a long way off, the Fed chairman said, and when it eventually does occur it would come with plenty of advance notice.

Look for U.S. inflation to trend lower in the second half

We expect some inflation volatility in the near-to-medium term as economic activity resumes and price comparisons with weak year-earlier numbers temporarily push inflation above the Fed's 2% target.

  • We don't expect these cyclical effects to result in a sustained inflationary trend given structural forces including technology.
  • We expect inflation will trend lower in the second half of the year, bringing our outlook for full-year inflation to a range of 1.6% to 1.8%.

Notes:

  • All investing is subject to risk, including possible loss of principal.
  • Investments in bonds are subject to interest rate, credit, and inflation risk.
  • Investments in stocks or bonds issued by non-U.S. companies are subject to risks including country/regional risk and currency risk. These risks are especially high in emerging markets.
  • 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.