Join Fund Library now and get free access to personalized features to help you manage your investments.
Last time, we looked at Vanguard’s July quarterly update for Canada, considering the impact of rising rates and slowing economic growth on the outlook. This time, we’ll look at our outlook for the U.S. as well as future expected returns for global and Canadian bonds and equities.
We have downgraded our expectations for the U.S. GDP growth in 2022 from around 3.5% at the start of the year to about 1.5%. The factors that led to our downgrade will likely continue through 2022 – namely, tightening financial conditions, wages not keeping up with inflation, and lack of demand for the U.S. exports. Labor market trends are likely to keep downward pressure on the unemployment rate through year-end, though increases in 2023 are likely as the impacts of Fed policy and slowing demand take hold.
Vanguard believes that a 2022 recession in the United States is unlikely, though risks grow through 2023. We place the likelihood of a U.S. recession in the next 12 months at about 25% and around 65% over 24 months.
We believe that a period of high inflation and stagnating growth is more likely than an economic “soft landing” of growth, and unemployment rates around or above longer-term equilibrium levels (about 2% for growth and 4% for unemployment).
US inflation has reached 40-year highs, eroding consumers’ purchasing power and driving the Federal Reserve to aggressively raise interest rates. Thus, we expect the target federal funds rates landing in a range of 3.25%-3.75% by the year-end. We expect a terminal rate of at least 4% in 2023 – higher than what we consider to be the neutral rate (2.5%) and above what’s currently being priced into the market. The latest U.S. headline inflation figure seems to have confirmed the U.S. Fed’s assertive stance to fight it as it raised the key interest rate by 75 bps on July 27.
Geopolitical risks, energy prices, and a Fed policy misstep resulting in a recession and/or stagflation remain the key risk factors for the economy. At present we see less sensitivity to these risks in the U.S. relative to Euro area, however geopolitical escalations coupled with persistently tighter financial conditions and oil prices in the $130-$150 (per barrel of WTI oil) range would present significant cyclical risks.
In the Euro area, headline inflation driven may spike to above 10% in the third quarter. Inflation has become widespread, spurring the European Central Bank into what it expects will be a “sustained path” of interest rate increases. On July 21, the ECB raised the key interest rate by 50 bps compared with an expectation of 25 bps, to 0.0%, ending the negative interest rates era for the region. We forecast economic growth to be about 2.0% to 3% for the full year. However, the geopolitical situation (especially Europe’s dependence on Russian natural gas) and the challenges of managing monetary policy for 19 countries put the euro area at a higher risk of recession than the United States in the next 12 months. A complete cutoff from Russian gas would likely lead to rationing and a recession.
The economy in China contracted by a greater-than-expected 2.6% in the second quarter and grew by just 0.4% compared with the second quarter a year earlier, highlighting the toll that the Covid-19 Omicron variant and associated lockdowns have exacted.
In our opinion, China will likely fall far short of policymakers’ annual growth target of 5.5% in 2022, given that it’s a challenge to achieve all three of their goals: the growth target; financial stability; and a zero-Covid policy. We believe the actual 2022 GDP growth rate will be just above 3%, far below China’s pace for many years. Given China’s zero-Covid policy, additional outbreaks resulting in renewed lockdowns could further detract from growth. The policy affects not just China’s economy, but the global economy as well.
Looking ahead, our fair-value projections reveal a global equity market that has gone through a significant price correction since November 2021 and is likely to produce better returns than previously estimated, over the next 10 years. With higher interest rates, bond return expectations have also improved compared to the last quarter.
With sizable reductions in equity values across the Canadian and global markets since January, we have improved our long-term outlook for equity returns. Our median 10-year returns expectations for Canadian equities at the end of May 2022 are in a range of 3.5% to 5.5%, about 0.5 percentage point higher than our January 2022 estimate. For global stocks (ex-Canada, unhedged) our forecasts have also improved by nearly 1.5% to a 4.4%-6.4% range.
With rising nominal yield levels observed across developed markets because of higher inflation and consistently higher interest rate expectations, we now see a marked improvement in bond returns over the next 10 years.
At the end of May 2022, we anticipate that median 10-year returns for Canadian bonds will range from 3% to 4%, around a 1.50 percentage point increase from our forecast in January. Likewise, for global aggregate bonds (ex-Canada, hedged), we now anticipate median 10-year returns of 2.7%-3.7%, about a 150-basis-point improvement since the beginning of the year.
In a nutshell, 10-year median return expectations have improved for both stocks and bonds, across Canada, U.S., Europe, U.K., China, and other regions improving investment returns outlook for long-term investors (see Figure 1)
Notes
1. All returns are annualized median expected returns over the next 10 years, as of May 31, 2022, compared to those at December 31, 2021 (in Figure 1), generated using Vanguard Capital Markets Model
Bilal Hasanjee, CFA, MBA, MSc Finance, is Senior Investment Strategist at Vanguard Investments Canada.
Disclaimer
© 2022 by Vanguard Group. All rights reserved. Reproduction in whole or in part by any means without prior written permission is prohibited. This article first appeared July 28, 2022, on the “Insights“ page of the Vanguard Group, Inc.’s website. Used with permission.
The views expressed in this material are based on the author’s assessment as of the first publication date (July 2021), are subject to change without notice and may not represent the views and/or opinions of Vanguard Investments Canada Inc. The author may not necessarily update or supplement their views and opinions whether as a result of new information, changing circumstances, future events or otherwise.
Certain statements in this presentation may be considered "forward-looking information" which may be material, involve risks, uncertainties or other assumptions and there is no guarantee that actual results will not differ significantly from those expressed in or implied by these statements. Factors include, but are not limited to, general global financial market conditions, interest and foreign exchange rates, economic and political factors, competition, legal or regulatory changes and catastrophic events. Any predictions, projections, estimates or forecasts should be construed as general investment or market information and no representation is being made that any investor will, or is likely to, achieve returns similar to those mentioned herein.
While this information has been compiled from proprietary and non-proprietary sources believed to be reliable, no representation or warranty, express or implied, is made by The Vanguard Group, Inc., its subsidiaries or affiliates, or any other person (collectively, "The Vanguard Group") as to its accuracy, completeness, timeliness or reliability. The Vanguard Group takes no responsibility for any errors and omissions contained herein and accepts no liability whatsoever for any loss arising from any use of, or reliance on, this material.
Information, figures and charts are summarized for illustrative purposes only and are subject to change without notice.
In this material, references to "Vanguard" are provided for convenience only and may refer to, where applicable, only The Vanguard Group, Inc., and/or may include its affiliates, including Vanguard Investments Canada Inc.
IMPORTANT: The projections or other information generated by the Vanguard Capital Markets Model regarding the likelihood of various investment outcomes are hypothetical in nature, do not reflect actual investment results, and are not guarantees of future results. VCMM results will vary with each use and over time.
The VCMM projections are based on a statistical analysis of historical data. Future returns may behave differently from the historical patterns captured in the VCMM. More important, the VCMM may be underestimating extreme negative scenarios unobserved in the historical period on which the model estimation is based.
Commissions, management fees, and expenses all may be associated with investment funds. Investment objectives, risks, fees, expenses, and other important information are contained in the prospectus; please read it before investing. Investment funds are not guaranteed, their values change frequently, and past performance may not be repeated. Vanguard funds are managed by Vanguard Investments Canada Inc. and are available across Canada through registered dealers.
This material is for informational purposes only. This material is not intended to be relied upon as research, investment, or tax advice and is not an implied or express recommendation, offer or solicitation to buy or sell any security or to adopt any particular investment or portfolio strategy. Any views and opinions expressed do not take into account the particular investment objectives, needs, restrictions and circumstances of a specific investor and, thus, should not be used as the basis of any specific investment recommendation. Investors should consult a financial and/or tax advisor for financial and/or tax information applicable to their specific situation.
All investment funds, including those that seek to track an index are subject to risk, including the possible loss of principal. Diversification does not ensure a profit or protect against a loss in a declining market. While the Vanguard ETFs are designed to be as diversified as the original indices they seek to track and can provide greater diversification than an individual investor may achieve independently, any given ETF may not be a diversified investment.
All monetary figures are expressed in Canadian dollars unless otherwise noted.
Join Fund Library now and get free access to personalized features to help you manage your investments.
Fund Library
