The next five years will be challenging, and investors need to have their eyes wide open.
The original article, written by Eric Rosenbaum is presented here by munKNEE.com – “ The internet’s most unique site for financial articles! (Here’s why)” – in an edited ([ ]) and revised (…) format to provide a fast & easy read. Visit our Facebook page for all the latest – and best – financial articles!
According to fund giant Vanguard Group, which manages roughly $5 trillion in assets and is a proponent of long-term investing, stock market investors need to be prepared for a significant downturn…
- There’s now a 70% chance of a U.S. stock market correction.
- The current probability is 30% higher than what has been typical over the past 60 years.
- A 10% negative return in the U.S. market in a calendar year (within a five-year forward period) has happened 40% of the time since 1960. That goes with the territory of being a stock investor.
- It’s unreasonable to expect rates of returns, which exceeded our own bullish forecast from 2010, to continue.
- Expect no better than 4 – 6% returns from stocks in the next five years.
Contributing to that outlook are market indicators that suggest “a little froth” in the market, according to the Vanguard chief economist, Joe Davis, who believes risk premiums, whether corporate bond spreads or the shape of yield curve, or earnings yields for stocks, have continued to compress below areas where we think it can be associated with fair value…
- The flattening in the yield curve — the spread between 2-year note yields and 10-year yields — is at the lowest level since before the financial crisis.
- The spread between junk bond yields and Treasuries recently has moved closer to the level before the financial crash than the long-term historical average.
…For investors who have done well with a U.S.-centric stock portfolio, it’s time to consider overseas equities. When international equities, whose valuations are not nearly as stretched, are added into a stock portfolio, the Vanguard research shows a drop to a 60% correction risk for a stock portfolio…The Vanguard research suggests that:
- developed markets stocks in the EAFE region will return more than U.S. stocks, at an estimated 5 to 7%, and emerging markets stocks possibly more, though with greater risk
- and a 20% investment-grade bond allocation would significantly reduce the downside risk in a portfolio.
Other major financial services firms are more cautious headed into 2018 as well, pointing to the length of the current bull market. Bank of America wrote in a recent note that:
- the current bull market will be the longest in history if it continues to Aug. 22, 2018,
- while the outperformance of stocks vs. bonds, at seven years running, would be the longest streak since 1929.
Now in the ninth year of an economic recovery, Vanguard’s chief economist said the position of the investor has flipped.
- Back in 2009 the economic outlook was poor but the investment outlook was very compelling. The progression through the economic recovery, although slow, now includes 80% of the world at full employment and an investment environment and outlook that is more muted.
“It’s important to separate what is expected of the global economy from the price being paid for it. In the United States, stock prices have already been bid up based on future business expansion,” Davis said…
Vanguard’s bottom line is that the trade-off — the equity risk premium — between stocks and bonds, or even stocks and cash, will be lower going forward than it has been historically, and lower than what it has been in the past five years, specifically.
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