Where does an investor find independent thinking?
Many "stock" firms have "too much skin in the game" to call out a dangerous stock market. But Vanguard is one firm that has been respected for its independent thought for many years. After all, they practically created the index fund trend that has saved investors trillions of dollars. And they manage all types of assets.
So, when Vanguard has some "top down" thoughts, it makes sense to listen.
The research they sent today carried a rather ominous title: As U.S. stock prices rise, the risk-return trade-off gets tricky. We don't disagree that future returns will be sub par from this entry point, but what are the alternatives?
Valuations favor overseas markets
The quants at Vanguard have an interesting way of presenting their outlook for various asset classes. Using their VCMM (Vanguard Capital Markets Model), they don't predict anything specific; they show probabilities of particular outcomes. For instance, they ask, "What is the chance of a 10% or worse decline", or "What is the expected range of returns over the next five years" for a particular asset type.
It's less conventional, which makes it interesting when taken in combination with other approaches.
Their general assessment is that US stocks only have a 38% chance of averaging a 5% or higher return over the next five years. International stocks have about a 50% probability. (Still not great.) Average return expectations over this period: 3% for US stocks and a 4% return for international. Ouch.
Perhaps a more interesting takeaway from this report is that a global balanced portfolio has similar return potential to US equities, but with far less expected volatility. We're still talking about modest returns (3-5% on average) but with only a one-in-four chance of losing 10% in a given year.
Investors won't likely believe this right off the bat. But one bad year may make them believers. In the "lost decade" of 2000 - 2010, the S&P500 returned a total of -8% But it didn't get there by going down a steady 3% per year, while delivering a 2% annual dividend. No, the S&P earned minus 8% with great volatility. And some up years to draw you back in.
Vanguard concludes with some wisdom
"Decisions around saving more or spending less will be as important as staying diversified and controlling costs. Adhering to investment principles such as long-term focus, disciplined asset allocation, and periodic portfolio rebalancing will be more crucial than ever before."