What does the prospect of only gradual economic growth mean for employment?
Peter Westaway: A lot depends on the fate of furloughed workers. Official measures of unemployment across the globe have risen by historically unprecedented amounts in a short time. And unfortunately, in many countries the true unemployment picture is even worse once furloughed workers are considered—those who are not working but are being paid by governments or employers. There’s a chance that furloughed workers could move straight back into work as lockdowns end, which would make this type of unemployment not so costly. But there’s a risk that high unemployment will persist, especially considering those who have already lost jobs permanently and the furloughed workers who may not easily move back into work.
At the end of last year, Vanguard was expecting inflation to remain soft. Has your forecast changed in light of the pandemic?
Joe Davis: Not significantly. Many commentators have talked up the prospect of a resurgence in inflation in 2021, particularly as the debt-to-GDP ratios of developed economies have increased dramatically because of spending to mitigate the effects of the pandemic. We think it’s more likely that inflation overall will be held in check by demand lagging a rebound in supply in all the major economies, especially in face-to-face sectors that we believe will experience a high degree of consumer reluctance until there is a vaccine. That, in turn, could set the stage for central banks to maintain easy terms for accessing money well into 2021.
Let’s get to what investors may be most interested in—Vanguard’s outlook for market returns.
Joe Davis: In short, stock market prospects have improved since the market correction, while expected returns from bonds remain subdued. Let’s take a closer look at global stocks first. They lost more than 30 percentage points earlier this year and volatility spiked to record levels, then they rallied strongly to regain most of their losses. Despite the negative macroeconomic outlook, we believe there is a reasonable basis for current equity market levels given the impact of low rates, low inflation expectations, and the forward-looking nature of markets.
With current valuations lower than at the end of last year and a higher fair-value range because of lower interest rates, our outlook for U.S. and non-U.S. stock returns has improved considerably for U.S.-based investors. Over the next ten years, we expect the average annual return for those investors to be:
- 4% to 6% for U.S. stocks
- 7% to 9% for non-U.S. stocks
Such differentials, which change over time, help explain why we believe portfolios should be globally diversified.
As for bonds, current yields normally provide a good indication of the level of return that can be expected in the future. With monetary policy having turned more accommodative, our expectation for the average annual return for U.S.-based investors has fallen by about 100 basis points since the end of 2019, to a range of 0% to 2% for U.S. and non-U.S. bonds.
Admittedly, we are in a low-yield environment with low forecast returns for bonds, but we expect high-quality globally diversified fixed income to continue to play the important role of a risk diversifier in a multi-asset portfolio.
It did so earlier this year. Consider a globally diversified portfolio with 60% exposure to stocks and 40% exposure to currency-hedged global fixed income, from a U.S. investor’s perspective. It is true that over a few days, the correlation between the global equity and bond markets was positive and that they moved relatively in tandem, but for the first half of 2020, a globally diversified bond exposure acted as ballast, helping to counter the riskier stock component of the portfolio.