What to expect from investment markets in 2016 and beyond

Vanguard’s economic and investment outlook is now available.

The New Year has begun in an unsettled fashion with global equity markets suffering heavy losses in the first weeks of trading, leaving investors feeling nervous about the outlook for 2016. At times like these, super members may feel tempted to make significant portfolio adjustments and deviate from their investment plan. Whilst the immediate effect of these emotional moves may not be felt, somewhere in the future investment goals may not be achieved.

During volatile markets, it can be difficult to ignore the media headlines. But for long term investors, this is often the best thing to do. In our 2016 Economic and Investment Outlook, we look beyond the short term and discuss major global economic and investment themes, and offer projections for global investment returns over the next decade.

So what’s the outlook for 2016 and beyond?

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Fragile growth

We think world economic growth will remain frustratingly fragile, with the six-year-old global recovery continuing at a modest pace, marked by occasional growth scares.

Looking further ahead, we expect weaker inflation, persistent low interest rates and lower growth across developed countries over the next decade compared with pre-GFC levels, due largely to slower credit, productivity and labour force growth.

As economic growth remains subdued, we expect all asset classes to deliver lower nominal yields. However, given the low level of inflation, we still expect fair real inflation-adjusted returns.

Fair wind for equities…

When it comes to global equities, we predict nominal returns centred in the range of 7-10%, and real equity returns broadly in line with historical averages.

Back in Australia, we don’t believe equities are overvalued when adjusted for low interest rates. We also predict long-term median equity returns to centre in the range of 7-10%, slightly below the historical average of around 10%.

…more headwinds for bonds

While the US Federal Reserve raised interest rates in December 2015 for the first time since the GFC, further increases are likely to be measured and gradual. So as rates remain low by historical standards, we predict a guarded outlook for bonds and cash. The fixed income market is likely to remain positive yet muted, with median returns of 2.5-3.5%.

So what does this mean for your client portfolios?

Take a total view

While interest rates are likely to remain low for longer, that’s no reason to abandon whole asset classes.

Despite lower returns, we encourage investors to look at the role of fixed income from a perspective of balance and diversification rather than outright returns. High-grade or investment-grade bonds can act as ballast in a portfolio, buffering losses from riskier assets such as equities.

The recent drops in share market values are a case in point where conservative bond portfolios remained in positive return territory.

In the figure below, we provide real return projections for three typical diversified portfolios—conservative, balanced and growth. We expect below-historical-average returns for the conservative portfolio given the higher allocation to cash and bonds. In contrast, a growth portfolio should deliver returns more in line with historical averages given a higher allocation to equities and property.

Figure - Projected ten-year real return outlook for balanced portfolios

Note: Forecast displays 5th/25th/75th/95th percentile ranges of 10,000 VCMM simulations for projected real returns for balanced portfolios in AUD. The equity portfolio is 50% Australian equity and 50% global ex-Australia equity. The bond portfolio is 40% Australian bonds and 60% global ex-Australia bonds. For details, see Vanguard’s 2016 economic and investment outlook (Davis, Wang, Gray, and Ahluwalia 2015).
Past performance is not an indicator of future performance.
Source: Vanguard.

Setting reasonable expectations

Neither fund managers nor super members can control markets, but we can certainly manage our expectations and behaviour. During times of uncertainty, investors are better off sticking with their investment plan than to make sudden changes to their asset allocation. This will ensure they have the best possible chance of meeting their investment goals.

You can read our full economic and investment outlook for 2016 here.

Alexis Gray
Economist, Vanguard Australia

Vanguard Investments Australia Ltd (ABN 72 072 881 086 / AFS Licence 227263) is the product issuer. We have not taken yours or your clients’ circumstances into account when preparing this article so it may not be applicable to the particular situation you are considering. You should consider yours and your clients’ circumstances, and our Product Disclosure Statements (“PDSs”), before making any investment decision or recommendation. You can access our PDSs at vanguard.com.au or by calling 1300 655 205. Past performance is not an indication of future performance. This article was prepared in good faith and we accept no liability for any errors or omissions.

© 2016 Vanguard Investments Australia Ltd. All rights reserved.