Vanguard s economic & market outlook Q3 2016 Paul Bosse, CFA Vanguard Investment Strategy Group
A world of extremes 2
Three secular forces & the key megatrend Technology Demographics The future of employment & the workforce Globalization 3
Key economic/portfolio points Convergence to slower global growth Cautious central banks = slow rate of normalization Manage return expectations to be lower 4
U.S. key economic/portfolio points Job growth strong, especially in services Fed remains accommodative Inflation remains low but watch labor gains 5
Policy rate (%) The Fed anchored by global central bank policy Convergence of central bank policy rates 20 15 10 5 1% is likely high water mark for U.S. Fed Funds rate Key: Low rates are secular, not cyclical European QE program continues and U.K. easing likely given Brexit 0-5 1972 1977 1982 1987 1992 1997 2002 2007 2012 2017 Eurozone US U.S. UK U.K. Japan Note: Dashed lines indicate future projected policy rates. Sources: Vanguard calculations, using data from the Federal Reserve, Bank of England, European Central Bank, Bank of Japan, and Thomson Reuters Datastream. 6
European key economic/portfolio points Growth positive but slower than elsewhere Further ECB support, given Brexit, low growth, and low inflation Geopolitical risks mounting 7
Economic Policy Uncertainty Index Recession likely in U.K. due to Brexit, but less so in Europe Uncertainty spikes Central banks expected to respond 700 600 500 400 300 200 100 UK Europe US Rates 2.5 2 1.5 1 0.5 0 2005 2007 2009 2011 2013 2015 0 2013 2014 2015 2016 2017 2018 2019 2020 2021 Policy Rate June 2015 Pre-Brexit Post Brexit Sources: Baker, Bloom,and Davis Economic Policy Uncertainty Index (http://www.policyuncertainty.com/) Source: Bloomberg data on overnight index swaps. 8
Chinese key economic/portfolio points Growth slowdown continues but is expected Economic changeover happening but bumpy Leadership questioned 9
GDP growth rate (%) Price-to-earnings earnings ratio EM equity markets: The bar has been lowered Growth has consistently disappointed and valuations reflect it 8 24 7 6 5 4 3 Actual growth Expected in 2010 2012 2014 2016 Vanguard expectations 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 22 20 18 16 14 12 10 2010 2011 2013 2014 2016 United States Emerging markets Markets Developed non-u.s. Sources: Vanguard calculations based on data from International Monetary Fund, Thomson Reuters Datastream, Moody s Analytics, Federal Reserve System, and Standard and Poor s. Notes: (Left-hand chart) Each year's expected projections are based on April's data release of the World Economic Outlook Database. Actual growth, between 2010 and 2015, is determined by the most recent database released April 12, 2016, using the metric gross domestic product, constant prices. Right-hand chart Notes: Figure displays the price-to-earnings ratio defined by the most recent price divided by the 36-month average of trailing earnings. United States is represented by the MSCI United States Index, developed markets non-u.s. is represented by the MSCI All-World U.S. Index, and emerging markets is represented as the MSCI Emerging Markets Index. All three indexes are denominated in U.S. dollars and represent an unhedged position with data as of June 30, 2016. 10
Yield Interest rates low rates are secular, not cyclical 18% 16% History Forecast 14% 12% 10% 8% 6% 4% 95th 2% 50th 0% 5th 3/31/1871 3/31/1896 3/31/1921 3/31/1946 3/31/1971 3/31/1996 3/31/2021 10 10-year U.S. Treasury Yield yield IMPORTANT: The projections or other information generated by the Vanguard Capital Markets Model (VCMM) regarding the likelihood of various investment outcomes are hypothetical in nature, do not reflect actual investment results, and are not guarantees of future results. 10-year Treasury yield projections based on 10,000 simulations from VCMM as of September 2015. Results from the model may vary with each use and over time. For more information, please see the important information slide. Sources: Vanguard calculations, based on data from Robert Shiller website, at aida.wss.yale.edu/~shiller/data.htm. 11
Probability Projected global fixed income ten-year outlook Expected average return of fixed income: June 2010 30% 25% 20% 15% 10% 5% 0% Less than 1% 1 to 1.5% 1.5 to 2% 2 to 2.5% 2.5 to 3% 3 to 3.5% 3.5 to 4% 4 to 4.5% More than 4.5% 10-year annualized return Outlook as of June 2010 IMPORTANT: The projections or other information generated by the VCMM 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 global fixed income returns in USD. Simulations are as of September 30, 2015. Results from the model may vary with each use and over time. For more information, please see the important information slide. Notes: Figure displays projected range of potential returns for portfolios of 70% U.S. bonds/30% ex-u.s. bonds, rebalanced quarterly. For details, see Vanguard s economic and investment outlook (Davis, Aliaga-Diaz, Westaway, Wang, Patterson, and Ahluwalia 2015). Source: Vanguard. 12
Probability Projected global fixed income ten-year outlook. Dramatically lower. Expected average return of fixed income: March 2016 & June 2010 30% 25% 20% 15% 10% 5% Global bond returns 1926-2015 5.4% 1970-2015 7.6% 0% Less than 1% 1 to 1.5% 1.5 to 2% 2 to 2.5% 2.5 to 3% 3 to 3.5% 3.5 to 4% 4 to 4.5% More than 4.5% 10-year annualized return Outlook as of March 2016 Outlook as of June 2010 IMPORTANT: The projections or other information generated by the VCMM 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 global fixed income returns hedged in USD. Simulations are as of March 31, 2016. Results from the model may vary with each use and over time. For more information, please see the important information slide. Notes: Figure displays projected range of potential returns for portfolios of 70% U.S. bonds/30% non-u.s. bonds hedged in USD, rebalanced annually. For details on benchmarks used for historical returns, see Indexes used in our historical calculations, on page 5 of Vanguard s economic and investment outlook (Davis et. al 2015). Source: Vanguard. 13
Maintain a long-term perspective Average return on U.S. stock: VCMM estimated probability distribution 25% 20% 15% 10% 5% 0% Less -20% to -16% -16% to -12% -12% to -8% -8% to -4% -4% to 0% 0% to 4% 4% to 8% 8% to 12% 12% to 16% 16% to 20% 20% to 24% 24% to 28% 28% to 32% 32% to 36% 36% to 40% More 1-year returns IMPORTANT: The projections or other information generated by the VCMM 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 VCMM, derived from 10,000 simulations for U.S. equity returns and fixed income returns. Simulations as of December 31, 2015. Results from the model may vary with each use and over time. For more information, please see the Important information slide. Notes: Figure displays projected range of potential returns for U.S. equities, rebalanced annually. For details, see 'Vanguard s economic and investment outlook' (Davis et al. 2015). Source: Vanguard. 14
Maintain a long-term perspective Average return on U.S. stock: VCMM estimated probability distribution 25% 20% 15% 10% 5% 0% Less -20% to -16% -16% to -12% -12% to -8% -8% to -4% -4% to 0% 0% to 4% 4% to 8% 8% to 12% 12% to 16% 16% to 20% 20% to 24% 24% to 28% 28% to 32% 32% to 36% 36% to 40% More 1-year returns 10-year returns IMPORTANT: The projections or other information generated by the VCMM 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 VCMM, derived from 10,000 simulations for U.S. equity returns and fixed income returns. Simulations as of December 31, 2015. Results from the model may vary with each use and over time. For more information, please see the Important information slide. Notes: Figure displays projected range of potential returns for U.S. equities, rebalanced annually. For details, see 'Vanguard s economic and investment outlook' (Davis et al. 2015). Source: Vanguard. 15
Probability Equity market expected returns subdued, but fair relative to inflation and other asset classes Expected average return of global equity market March 2016 & June 2010 30% 25% 20% Global equity returns 1926-2015 10.0% 1970-2015 4.3% 15% 10% 5% 0% Less than 0% 0 to 3% 3 to 6% 6 to 9% 9 to 12% 12 to 15% 15 to 18% More than 18% Current 10-year outlook Outlook as of June 2010 10-year annualized return IMPORTANT: The projections or other information generated by the VCMM 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 global equity returns in USD. Simulations are as of March 31, 2016. Results from the model may vary with each use and over time. For more information, please see the important information slide. Sources: Vanguard. Notes: Figure displays projected range of potential returns for portfolios of 60% U.S./40% ex-u.s. equities unhedged in USD, rebalanced annually. For details on benchmarks used for historical returns, see Indexes used in our historical calculations, on page 5 of Vanguard s economic and investment outlook (Davis et. al 2015). 16
Reduce your portfolio return expectations 20/80 Equity/Bond 25 th 50 th 75 th 1926-15 20% / 80% 2.6% 3.5% 4.4% 6.5% 60% / 40% 3.3 5.9 8.4 8.9 80% / 20% 3.4 6.9 10.4 10.1 60/40 80/20 20/80 60/40 80/20 0 1 2 3 4 5 6 7 8 9 10 IMPORTANT: The projections or other information generated by the VCMM 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, 2015. Results from the model may vary with each use and over time. Note: Forecast displays 5th/25th/75th/95th percentile ranges of 10,000 VCMM simulations for projected nominal returns for balanced portfolios. Source: Vanguard. 17
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