The stock market has had a rough few days. It could be just a taste of the sluggish returns investors can expect over the next decade, according to Vanguard.
On Monday the S&P 500 fell 3% as worries about the U.S. economy was spread around the globe. And while the index has still returned 20% in the past 12 months, it may be no accident the market is starting to look shaky.
Today’s high stock prices may dog the market for years to come, Vanguard says. What’s more, the investing giant thinks bonds are poised to outpace stocks over the next decade.
The stock market has enjoyed outsize gains thanks to big tech profits, says Vanguard economist Kevin Khang. These days, however, valuations are “pretty stretched.”
Meanwhile bonds, benefiting from the Fed’s effort to raise rates, look better than they have in years. In contrast to stocks, bonds are very attractive, he adds.
In line with this thinking, Vanguard recently forecast annual U.S. stock returns over the next decade of 3.4% to 5.4%. By contrast, Vanguard’s outlook for U.S. bonds is a rosier 4.6% to 5.6%, according to the firm’s midyear outlook published last month.
Picking bonds to beat stocks for as long as a decade is a bold call for a firm typically known for sticking to tried-and-true investing rules. While far more volatile, stocks have delivered average returns of about 10.2% over the past 100 years. That is roughly double the average return for bonds.
Vanguard’s hesitation over stocks is largely tied to price-to-earnings (P/E) ratios, Khang says. While the S&P 500’s decadeslong historical P/E is about 19, today stocks are trading at 25.
Of course, price-to-earnings ratios can remain out of whack for years at a time. One popular valuation metric, the Shiller P/E, has been above its long-term average for upward of a decade. Still, Vanguard argues the stock market will eventually return to the norm, which suggests tepid stock returns in coming years.
Khang notes elevated stock prices are underpinned by genuinely outsize earnings growth among big stocks such as the Magnificent 7. Despite their enormous size, these companies have managed to rack up double-digit profit gains in recent years.
Still, while these companies may yet prove transformational to the economy, Khang says their earnings momentum will eventually fade. That has happened historically–following the dot-com bubble, with the Nifty Fifty stocks in the 1960s, and with companies that powered electrification in the 1920s.
“Earnings growth can’t just continue to go grow at that level,” Kang says.
Unlike stock investors, bondholders are coming off some difficult years. Bond prices, which move inversely to interest rates, languished as the Federal Reserve spent much of 2022 and 2023 raising rates.
Now, however, bond investors are much better positioned. Bonds offer attractive yields, and enjoy the prospect of a tailwind once the Fed does start to lower rates, as most Wall Street traders believe, in September.
Khang says Vanguard arrives at its 10-year forecast for roughly 5% annual bond returns by taking today’s 10-year Treasury yield of just under 4% and tacking on a risk premium of roughly one percentage point.
Indeed, the Vanguard Intermediate-Term Corporate Bond Index Fund
VCIT boasts a yield of 5.1%, with an average duration of 7.4 years—suggesting investors willing to lock in those rates today will enjoy them into at least the 2030s.
https://www.barrons.com/articles/bonds-market-outlook-vanguard-decade-71dda28a?mod=hp_LEAD_1_B_2
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