What to Expect From Stocks and Bonds
The pros agree: Don't expect buoyant returns from U.S. stocks going forward.
The following is an excerpt from Christine Benz's recent webcast, Tune Up Your Portfolio in Uncertain Times. Watch the full webcast.
Christine Benz: We've seen a long run of tremendous equity market performance. We've also seen a long run of pretty decent bond market performance, last year notwithstanding. So that has many market forecasters, when they're called upon to forecast what the stock and bond markets might return over the next decade, that has many of these folks calling for fairly muted returns, at least on U.S. stocks and on U.S. high-quality bonds.
This is a slide that I grabbed from my colleagues in Morningstar Investment Management. They periodically put out these capital markets assumptions. And what you can see is a very low return expectation for U.S. stocks, just 1.6%, and a similar return expectation for U.S. bonds. And they arrive at these forecasts by looking at a couple of different things. So, for stocks, they're looking at their expectation of earnings growth, they're looking at where dividend yields are, and they're looking at their expectation of price multiple contraction or expansion. Because U.S. equity market valuations are still pretty high, they're thinking that the U.S. market valuation, U.S. multiples, will probably contract over the next decade. That's one reason why those return expectations are so muted. For fixed income, the prediction is fairly straightforward. Starting bond yields are a pretty good predictor of what you're apt to earn from the bond market over the next decade. We're low today in terms of fixed-income yields. And so, that depresses the return prospects for fixed-income assets. These figures are not inflation-adjusted, so it's important to factor that in as well. So, if we have even a normal inflation rate over the next decade, that means that the investor in a 60/40 U.S. portfolio will probably be sort of flatlining over the next decade.
If there's a good news story here, I would say it's that our team is expecting relatively better results from non-U.S. stocks, especially emerging-markets stocks but also developed-markets stocks, over the next decade. That's another potential catalyst for reviewing your U.S. versus non-U.S. exposure, especially if you've been practicing a policy of benign neglect, it's potentially worth revisiting those exposures.
I would also urge you to check out my compendium of capital markets forecasts. This is something I put together at the beginning of every year. I recently put one out for 2022. It incorporates what our Morningstar Investment Management team is thinking, but it also incorporates outside firms' capital markets forecasts, because I do think it's helpful to get an array of opinions on this. I would note that our Morningstar team tends to be sort of toward the low end of return forecasts, especially for U.S. stocks. I would say there's more commonality in terms of the forecasts when it comes to fixed-income assets, in part because the relationship between starting yields and returns is so straightforward. But I would survey those forecasts to just get your arms around what these firms are thinking in terms of what you might expect various asset classes to return. To affirm, I would say that they're all forecasting better returns from non-U.S. stocks relative to U.S. stocks over the next decade, and that owes largely to lower starting valuations on non-U.S. stocks today.