And if so, do we need to own the S&P 500 SPX — the benchmark index of large-company stocks that is the bedrock of almost every portfolio?
Those are the shocking questions raised by the recent asset-allocation paper from Vanguard, of all firms.
Not only does the firm reckon that bonds will probably do better than stocks over the next decade, but it expects that U.S. large-company stocks, and especially U.S. large-company growth stocks, will look even worse.
And market developments since Vanguard ran these calculations make the numbers today even more appalling.
It’s especially remarkable that this should come from Vanguard, the investor-owned index-fund giant. The firm and its legendary founder, the late Jack Bogle, are famous for recommending buy-it-and-forget-it, passive, long-term investments in U.S. stocks.
“My view [is] that a U.S.-only equity portfolio will serve the needs of most investors,” Bogle wrote in “The Little Book of Common Sense Investing.” “Buy a fund that holds this all-market portfolio, and hold it forever.” If you want to add some stability, balance it with a low-cost bond index fund, he added. Hence the Vanguard Balanced Index Fund VBAIX, which is 60% invested in the S&P 500 and 40% in a U.S. bond index.
Now look at Vanguard’s latest numbers.
Their “Capital Markets Model Forecast” sees U.S. large-company stocks earning you somewhere between 2.5% and 4.5% a year, on average, for the next decade.
That’s before counting the costs of inflation, which Vanguard sees as averaging 1.9% to 2.9% a year over the same period. (It’s also before any investment fees — and many people are paying about 1% a year.)
So in “real” or constant dollars — in other words, after deducting inflation — Vanguard’s model sees big U.S. stocks earning you somewhere between 2.6% and minus 0.4% a year, on average, over the next decade. That’s enough to turn $1,000 now into … somewhere between $1,300 and $960 by 2035.
Booyah!
Don’t buy an iPhone today! Put that money aside and invest it in the S&P 500 — and in 10 years’ time, if you’re lucky, you’ll … be able to buy an iPhone.
Compare that with the record of the past century, when, on average, the S&P 500 has doubled your money over 10 years, in constant dollars.
Let alone the past 10, when it’s earned you more than 150%.
But if the Vanguard numbers look bad, consider this: Their model implies absolute catastrophe for those who invest in large U.S. growth stocks — the kind currently dominating the market. The firm sees a passive investment in U.S. growth losing somewhere between 20% and 40% of its value in real or constant dollars over the next 10 years. (That’s based on forecast nominal average returns of minus 0.4% a year to minus 1.6% a year, and their inflation estimates.)
Yikes.
Maybe in 2035 you won’t be able to buy an iPhone.
To give you an idea of how much the current market is dominated by “growth” stocks: I used FactSet data to analyze the current constituents of the S&P 500. I split them into those trading for more than 20 times forecast per-share earnings, a reasonably lofty “growth”-type rating, and those trading for less than 20 times, which we will call (or pretend constitutes) “value.”
Result? Those selling for price-to-earnings ratios of 20 or higher made up just under half of the stocks in the index (240) by number. But they made up nearly three-quarters of the index (73%) by value. Those expensive stocks, including megacaps like Tesla TSLA and Nvidia NVDA, boasted a total market value of around $40 trillion. All those stocks selling for less than 20 times forecast earnings? Just $15 trillion.
So, just to recap, Vanguard’s numbers seem to suggest anyone investing in large U.S. growth stocks might just as well set fire to some of their money now and save themselves the wait. And if you have your money invested in the S&P 500, by one measure about three-quarters of it is invested in … large U.S. growth stocks.
Enjoy.
No wonder the firm prefers bonds — pretty much anything looks preferable to this Bonfire of the Benjamins. Incidentally, the U.S. Treasury now tells me the “real,” constant dollar return on 10-year inflation-protected Treasury bonds, aka TIPS, is now 2.2% a year. Which means they guarantee about a 24% rise in your purchasing power over the next decade. Or, nearly as much as the best-case scenario for the S&P 500, according to the Vanguard model, with effectively no risk.
It’s not all doom and gloom. Vanguard’s model sees very good returns over the next decade for the stocks of international developed markets such as Europe, Japan and Australasia, and decent returns for large U.S. “value” stocks, small U.S. stocks and even U.S. real-estate investment trusts. It also sees decent returns for emerging-market stocks.
The standout in the Vanguard model is the asset class of developed international stocks. (Incidentally, Vanguard’s Developed Markets Index Fund VTMGX includes Canadian stocks as well as the so-called EAFE markets, standing for Europe, Australasia and Far East.) The firm’s model sees developed international markets earning you between 50% and 100% returns over the next decade in constant dollars — in other words, in real, purchasing-power terms.
According to their analysis, U.S. large value stocks and U.S. small stocks — think the Vanguard Value ETF VTV and Vanguard Small-Cap ETF VB — are likely to give total returns over a decade of between 15% and 50% in real, inflation-adjusted returns, just slightly ahead of REITs. Not great, but OK.
There are lots of caveats that go with all these numbers. Nobody actually knows what the next 10 years will hold — a warning that is just as true for the bulls as it is for the skeptics. Vanguard points out that its forecasts “are not intended to imply portfolio-construction advice, which should reflect such factors as an investor’s objectives and risk tolerance, as well as asset-class correlations and the dispersion of expected returns.” As everyone is supposed to understand by the time they graduate first grade, actual results may vary from expectations.
If you’d sold the S&P 500 on Nov. 8, the day of Vanguard’s calculations, you’d have missed out on a 50% rise. People spent the late 1990s warning that the stock market was in a bubble, only to see it keep going up and up and up. It didn’t actually crash until all the bears finally got fired — which happened en masse in December 1999 and January 2000. (I am not kidding.)
I asked Vanguard investment strategist Todd Schlanger why, given these forecasts, anyone should own U.S. stocks as well as international stocks, growth stocks as well as value stocks, and large caps as well as small caps.
His response? Never bet the house, even on a model. Best practice in portfolio construction is to avoid overly concentrated positions, he points out. Vanguard sets limits on how far it wants to deviate from a neutral position. So, for example, their “Time Varying Asset Allocation” model won’t put more than 40% of its stock-market investments in non-U.S. markets, or more than 70% in “value” stocks.
“We believe it can be wise to establish certain constraints and risk budgets for time-varying asset-allocation strategies,” he wrote in an email. “In the case of the TVAA strategy in the paper, we allow value/growth to allocation within a 30% to 70% range of relative allocations. We believe this allows sufficient room for the strategy to benefit from the relative attractiveness of the segment while maintaining diversification.”
Schlanger also conceded that the “primary risk” to the strategy is “model forecast risk.”
