Global economy strong, but investment outlook not so much: Vanguard

The world’s biggest mutual fund company says it’s surprised by the global economy’s strength this year, but that doesn’t mean it’s more optimistic about the investment outlook.

Investors should brace for a decade of “muted returns,” said Nathan Zahm of Vanguard Group, reiterating the $4.5 trillion money manager’s view that equity returns will drop to 5 to 8 percent per year, while those for bonds will decline to 2 to 3 percent. That’s even as the world economy posts better-than-expected performance in 2017, helped by growth in Japan and Europe, the Hong Kong-based senior investment strategist said.

The S&P 500 Index of U.S. shares has surged 12 percent this year, heading for its biggest annual gain since 2013, while just one of 24 developed equity markets tracked by Bloomberg posted losses for the period. While stock investors have shrugged off political turmoil in the U.S. and increasing risk of a conflict with North Korea to focus on economic output and corporate profits, Vanguard suggests the good times will slow.

“This year was probably a surprise to the upside,” Zahm, 34, said in an interview during a visit to Tokyo. “Growth is relatively stable if not strengthening in some countries and market conditions and interest-rate conditions are still quite favorable,” he said. But “what we caution investors on, particularly given that landscape and given the very strong run we’ve had, is that forward-looking returns are now quite muted.”

The indexing giant has maintained for decades that low-cost passive funds tend to serve investors better over multiple market cycles than high-priced offerings. Vanguard’s view on the outlook for the next decade, previously expressed by founder Jack Bogle and Bill McNabb, who steps down as chief executive officer in January, is that the strong returns after the financial crisis just aren’t sustainable.

That’s partly due to valuations, Zahm said. The S&P 500, which averaged a 12 percent annual gain from 2009 through last year, traded at 19.2 times estimated earnings, the most expensive since 2002, after rising to a record close Tuesday.

It’s also because of subdued interest rates. The money manager cites an aging population, the globalization of the labor force and the rise of technology as factors that are fostering muted inflation expectations.

“Even if we have this strong economic growth, with where valuations are and with where interest rates are, having expectations for future significant returns like we’ve recently experienced, while possible, isn’t necessarily probable,” said Zahm, who joined Vanguard in 2011.

In this environment, the low-cost indexer is telling investors to control what they can control, such as how much they spend and save. Many investors will find themselves overweight in equities and needing to adjust their portfolios, said Zahm, who’s part of a 70-strong global investment-strategy team headed by the firm’s global chief economist Joseph Davis.

Aside from suggesting a need to keep costs low, Zahm says his team is also cautioning investors on risk awareness and tolerance ahead of the lower investment returns the money manager foresees.

If the worst-case scenario happens, “will you still remain solvent? Will you still remain able to meet your objectives and meet your obligations?” Zahm said. “In a low-return environment, we do see a lot of investors certainly asking themselves that question.”

Related Topics: Vanguard Group