Vanguard recently released their Economic and Stock Market Outlook for 2017, a 40-page report detailing what you should generally expect as an investor in 2017. Vanguard is saying that we should expect stabilization and slow growth in the global economy – and not the extremes of stagnation or acceleration. You can read the full report by clicking here.
Here are the main takeaways from the report:
Low growth but not stagnation.
Since the end of the Great Recession, economic growth has been slow and disappointing. Some people believe the world is headed for Japanese-style secular stagnation. And yet the modest global economy – as weak as it’s been at times – has endured.
- Vanguard anticipates “sustained fragility” for global trade and manufacturing.
- The growth outlook for developed markets remains modest but steady.
- Increasingly sound economic fundamentals (supported by U.S. and European policy) should help offset weakness in the U.K. and Japan.
- In the U.S., 3% GDP growth is possible in 2017, despited cooling job growth.
- Vanguard still believes that long-term U.S. growth of 2% is neither “subpar” nor something “new”, if you take into account lower population growth currently and the exclusion of the consumer-debt-fueld boost to growth between 1980 and the Great Recession.
Better than expected inflation in the U.S. and the U.K., slower inflation in the Eurozone.
- Many developed economies are likely to struggle to consistently achieve 2% core inflation over the medium term.
- Nevertheless, the most pernicious deflationary forces are waning.
- U.S. core inflation should modestly overshoot 2% in 2017, prompting the U.S. Federal Reserve to continue to raise rates.
- U.K. inflation should also overshoot following the post-Brexit depreciation of the pound.
- By contrast, inflation in the Eurozone will only return to target levels gradually.
Monetary Policy and Interest Rates
The U.S. Fed will continue to tighten rates. In the rest of the world, stimulus is still possible but will have less of an affect. Monetary policy in China is important but will be difficult in 2017.
- The U.S. Fed is likely to continue to tighten, raising rates to 1.5% in 2017 but leaving the fed funds rate below 2% through at least 2018.
- Throughout the rest of the world, monetary stimulus is still possible, but its benefits may be waning (and negative interest rates could be potentially harmful).
- Still, the European Central Bank and the Bank of Japan could add to the quantitative easing they implemented in 2016.
- Chinese policymakers might have the most difficult task of engineering a “soft landing” by lowering borrowing costs and the real exchange rate, without accelerating capital outflows from the country.
- The margin of error in China is slim, and Vanguard expects policymakers to continue to provide fiscal stimulus to the economy in 2017.
- The most important policy measure to look out for in China is the pace of reforms for the country’s state-owned enterprises, which are currently key sources of over-investment and excess capacity, which is slowing growth.
Not great given the low-rate environment, but still positive.
Vanguard’s outlook for global stocks and bonds is the most cautious it’s been in a decade, given fairly high equity valuations and the low-interest-rate environment. Global bond yields aren’t expected to increase much in 2017.
- Bonds: Return outlook remains positive yet muted. The 10-year U.S. Treasury yield is still expected to be within the 2.00%-2.25% range.
- Stocks: The medium-term outlook for global equities is in the 5-7% range (we’ve seen over the past several years that low economic growth doesn’t have to mean poor equity returns). Still, the long-term outlook is not bearish and can even be viewed as a positive when taking into account the low-rate environment.
By late 2016, market sentiment had quickly shifted from an overly pessimistic outlook of weak stagnation to an overly optimistic expectation of growth. Both views are incorrect.
Global growth should stabilize, not stagnate. Tightening labor markets should place modest upward pressure on otherwise low inflation. But further monetary stimulus (like negative interest rates) will prove unproductive in spurring growth.
Vanguard’s outlook for returns is modest compared with the heady returns experiences since the depths of the Global Financial Crisis. This guarded (but not bearish!) outlook is unlikely to change until short-term rates get a little higher and valuation metrics become more favorable.