Vanguard’s economic and investment outlook is modest but steady growth with muted but positive returns
At the end of every year we update our economic and investment outlook to provide investors with an overview of the major global trends and offer projections for returns over the next decade.
We’ve now finalised our 2017 economic and investment outlook and it makes for an interesting reading.
We believe global growth should remain low but not stagnate, higher inflation should be difficult to consistently attain despite ever-tightening labour markets, and further monetary stimulus in the form of negative interest rates will prove unproductive in spurring growth.
But low growth does not imply Japanese-style stagnation on a global scale. The modest recovery can be explained by three longer-term, supply-side forces – weakening demographics, expanding globalisation and advancing digital technology.
What’s your overall outlook for economic growth?
Our growth outlook for developed markets remains modest but steady. Increasingly sound economic fundamentals supported by US and European policies should help offset weakness in the UK and Japan. For the United States, 3% GDP growth is possible in 2017, even as job growth cools.
We continue to anticipate sustained fragility for global trade and manufacturing, given China’s ongoing rebalancing and the need for structural business-model adjustments across emerging-market economies.
Meanwhile, further monetary stimulus is unlikely to lift up the global economy as the benefits are waning and, in the case of negative interest rates, can prove harmful to the very credit-transmission channel that monetary policy attempts to prop up.
And when it comes to inflation, many developed economies are likely to struggle to consistently achieve their 2% core target over the medium term, given digital technology and excess commodity capacity in China and elsewhere.
What’s the picture in individual economies around the world?
We expect the US Federal Reserve to be more hawkish than anticipated this year, but more dovish longer term. The central bank is likely to raise the Fed Fund rate to at least 1.5% in 2017, while leaving it below 2% through at least 2018. Although the US economy is unlikely to accelerate materially above 3%, the short-term risks to both inflation and growth are tilted toward the upside, given the fading effects of weaker commodity prices, inventory overhang, the stronger dollar and the prospects for fiscal stimulus.
In Australia, we see growth of around 2.5-3%, as the drag from the end of the mining boom fades and dwelling investment continues to moderate. The case for further interest rate cuts has been weakened by a shift in global central banking policy and a stronger momentum within the domestic economy following a recent rebound in commodity prices. But we are still hesitant to call the bottom of the easing cycle, given the risks associated with inflation, the residential construction cycle and rising global trade frictions under a Trump administration. Core inflation will likely remain subdued, as labour market pressure continues to dampen wage growth.
In China, the protracted slowing trend in recent years is unlikely to be reversed any time soon, given industrial overcapacity, unfavourable demographics and falling productivity growth. Policymakers are likely to provide further monetary and fiscal support in a bid to cushion against downside risks and avoid a hard landing, though any large-scale stimulus appears unlikely. So we do not anticipate a Chinese hard landing in 2017, but we are bearish on China’s medium-term growth prospects.
The Euro area recovery is expected to proceed at a slightly slower pace, as uncertainty from Brexit negotiations and the upcoming German and French referendums weighs on activity.
What’s your outlook for asset classes?
Our outlook for global stocks and bonds remains guarded, given fairly high equity valuations and low interest rates, which we believe are here to stay.
Bonds. The return outlook for global fixed income remains positive, yet muted, with expected long-term median returns of 1% - 3%. We expect the diversification benefits of investment-grade fixed income in a balanced portfolio to persist under most scenarios.
Equities. Our medium-term return outlook for global equities remains in the 6% - 9% range. Our long-term outlook is not bearish and can even be viewed as a positive when adjusted for the low-rate environment.
What does all this mean for investor portfolios?
It’s important to take into account the impact of inflation on investor returns. The graph below compares projected real (inflation-adjusted) returns for 2016−2026 with historical returns for the conservative, balanced, and growth portfolios – 30% equities/70% bonds, 50% equities/50% bonds, 70% equities/30% bonds.
Figure 1. Projected real returns for balanced portfolios, 2016-2026
While inflation-adjusted returns for the next 10 years are likely to be moderately below long-term historical averages, the likelihood of achieving real returns in excess of those since 2000 is higher – for all but the most conservative portfolios.
What advice do you have for investors?
Of course, this recent investment period was marked by the global financial crisis and subsequent recovery. And our outlook for portfolio returns is modest compared with the heady returns experienced since the depths of the GFC. This guarded outlook is unlikely to change until we see higher short-term rates and more favourable valuations.
In some ways, the investment environment for the next five years may prove more challenging than the previous five, underscoring the need for discipline, reasonable expectations and low-cost strategies.
You can read our full economic and investment outlook for 2017 here.