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"The hallmarks of Vanguard market forecasts are our longer-term orientation."
Senior Investment Strategist, Investment Strategy Group, Vanguard
Every year brings a swathe of market and economic forecasts. Many of the forecasters are bold enough to focus on the single calendar year at hand. They purport to tell investors where, for example, the S&P 500 Index will stand at the close of trading on 31 December.
I do not want to impugn all efforts to see into the financial future. Indeed, I make my living forecasting market returns. Specifically, I oversee research into forecasting and the operation of the Vanguard Capital Markets Model®, which powers the view on asset classes we present in our annual economic and market outlook.
But if one spends any time considering market forecasts—ours or anyone else’s—it’s important to understand that there is a relationship between their horizons and their accuracy. Longer-term outlooks are more accurate.
Consider Wall Street forecasts of calendar-year S&P 500 Index price changes over the last dozen years. As shown in the chart, reality almost always defies such short-term prognostication.
The futility of short-term market forecasts.
Analyst forecasts of 1-year S&P 500 Index levels versus actual returns
Past performance is not a reliable indicator of future results.
Sources: Vanguard and Bloomberg.
Notes: Date between 3 January 2011 and 30 December 2022. Returns calculated in USD. The chart reflects a varying number of forecasts, ranging from a low of 11 for 2011 to a high of 22 for 2019, tracked by Bloomberg. Each was issued in December of the preceding year. Because they were made for the closing level of the S&P 500 Index, they were price-only—not total return—estimates, which would include the effects of dividend payments.
Most notably, in nine of the 12 years between 2011 and 2022, the index’s actual returns fell outside the generally wide range of analysts’ estimates. In all four years when share prices either declined or were flat, even the most pessimistic analyst proved too optimistic. In five years, the opposite occurred: even the most optimistic analyst underestimated the extent of share-price gains.
While often missing the proverbial dart board, Wall Street analysts’ 12-month forecasts underrepresent the downside risk of stocks. None of the median forecasts—and just 13 of the 198 underlying forecasts in our sample, which is less than 7%—anticipated falling share prices.
As it turned out, stocks declined in three of the 12 years and were flat in a fourth year. Such outcomes should not surprise investors, let alone Wall Street analysts, because stock prices have fallen roughly 25% of the time over the longer term. The S&P 500 Index recorded negative total returns in 26 of the 97 calendar years starting in 19261.
The few declines that analysts envisaged were modest to a fault. The largest forecast was just –7.7%. Stocks fell roughly three times as much in 2022, and the index’s 26 calendar-year losses since 1926 averaged -13%.
So much for one-year stock-price forecasts.
We seek to approach the future with the humility it deserves. That’s one reason why the hallmarks of Vanguard market forecasts are our longer-term orientation and our focus on the entire probability distribution of outcomes.
We do offer point forecasts—the median results of our simulations of potential returns—but we acknowledge the uncertainty of how markets will perform by presenting them as the central tendencies of estimated ranges of likely outcomes. For example, we expect euro area stocks to return between 1.6% and 10.2%, annualised, over the next decade2, with a median estimate of 5.9%.
There’s no magic in our selection of 10 years as our standard forecast horizon3. The key is taking a long enough view of markets to ensure that our valuation-based approach can be reasonably accurate. We recognise that, over longer periods, unusually high or low valuations tend to revert toward a fair-value level consistent with prevailing inflation and interest rates.
Other key elements of our market forecasts include sovereign-debt yield curves and credit spreads—the marginal yields that corporate and other bonds offer over and above sovereign debt as compensation for their higher risk.
The chart below shows that actual market returns have tended to fall inside the range of our forecast outcomes. Our overriding concern is being as accurate as possible about the performance of globally diversified, balanced portfolios—those comprising stocks and bonds—because we’ve long argued that most investors should maintain such portfolios.
Forecast versus actual 10-year annualised returns for globally diversified, balanced portfolios
Actual returns have been close to our expectations
Past performance is not a reliable indicator of future results. Any projections should be regarded as hypothetical in nature and do not reflect or guarantee future results.
Notes: This chart shows the actual 10-year annualised return of a 60% global equity/40% global bond (hedged) portfolio in EUR compared with the Vanguard Capital Markets Model (VCMM) forecast made 10 years earlier. For example, the March 2014 data at the beginning of the chart show the actual return for the 10-year period between 31 March 2004 and 31 March 2014 (solid line) compared with the 10-year return forecast made on 31 March 2004 (dashed line). After September 2022, the dashed line is extended to show how our forecasts made between 31 December 2012 and 30 September 2022 (ending between 31 December 2022 and 30 September 2032) are evolving. The interquartile range (darker grey shaded area) represents the area between the 25th and 75th percentile of the return distribution and the lighter grey shaded area represents the area between the 5th and 95th percentile. See footnotes for further details on asset classes.
Source: Refinitiv as at 31 October 2022 and Vanguard calculations in EUR, as at 30 September 2022.
IMPORTANT: The projections and other information generated by the VCMM regarding the likelihood of various investment outcomes are hypothetical in nature, do not reflect actual investment results and are not guarantees of future results. Distribution of return outcomes from VCMM are derived from 10,000 simulations for each modelled asset class. Simulations are every quarter, between 31 March 2004 and 30 September 2022. Results from the model may vary with each use and over time.
Past performance is no guarantee of future returns. The performance of an index is not an exact representation of any particular investment, as you cannot invest directly in an index.
While the accuracy of our calls on individual asset classes obviously could affect the accuracy of our outlook for diversified, balanced portfolios, we’re not especially concerned with any one asset class. Boldly telling the world where equity markets will stand 12 months from now may capture headlines, but we’re more concerned with giving investors realistic expectations.
Armed with realistic expectations, advisers can put clients on course to meet their long-term financial goals and, by avoiding the pitfalls of using short-term forecasts, build trust with clients over time.
1 Source: Vanguard.
2The low and high ends of this expected-return range reflect the 25th and 75th percentiles of our return forecasts. More extreme returns are possible. Our euro area forecasts are based on the companies listed in the MSCI Europe Total Return Index. Forecasted returns include the reinvestment of dividends and capital gains, calculated in EUR.
3 We forecast over 30-year horizons as well—typically for endowments and foundations, whose indefinite lifespans make them among the longest-term investors.
Investment risk information
The value of investments, and the income from them, may fall or rise and investors may get back less than they invested.
Past performance is not a reliable indicator of future results.
IMPORTANT: The projections and 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.
The Vanguard Capital Markets Model® is a proprietary financial simulation tool developed and maintained by Vanguard’s primary investment research and advice teams. The model forecasts distributions of future returns for a wide array of broad asset classes. Those asset classes include US and international equity markets, several maturities of the U.S. Treasury and corporate fixed income markets, international fixed income markets, U.S. money markets, commodities, and certain alternative investment strategies. The theoretical and empirical foundation for the Vanguard Capital Markets Model is that the returns of various asset classes reflect the compensation investors require for bearing different types of systematic risk (beta). At the core of the model are estimates of the dynamic statistical relationship between risk factors and asset returns, obtained from statistical analysis based on available monthly financial and economic data from as early as 1960. Using a system of estimated equations, the model then applies a Monte Carlo simulation method to project the estimated interrelationships among risk factors and asset classes as well as uncertainty and randomness over time. The model generates a large set of simulated outcomes for each asset class over several time horizons. Forecasts are obtained by computing measures of central tendency in these simulations. Results produced by the tool will vary with each use and over time.
Funds investing in fixed interest securities carry the risk of default on repayment and erosion of the capital value of your investment and the level of income may fluctuate. Movements in interest rates are likely to affect the capital value of fixed interest securities. Corporate bonds may provide higher yields but as such may carry greater credit risk increasing the risk of default on repayment and erosion of the capital value of your investment. The level of income may fluctuate and movements in interest rates are likely to affect the capital value of bonds.
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