Market perspectives: October 2021

September 27, 2021 | Vanguard Expert Perspective

Key highlights

• Because of the COVID-19 resurgence, we’re revising downward our forecast for full-year U.S. growth to around 6% from our previous expectation of around 7.5%.
• Vanguard has changed our outlook for the start of the Federal Reserve’s tapering of its asset purchases from the first quarter of 2022 to the fourth quarter of 2021.
• We foresee core inflation exceeding central bank targets in the United States and the United Kingdom in the months ahead and settling below the inflation targets in China and the euro area.
• Vanguard continues to expect that the U.S. unemployment rate will fall toward the mid-4% range by year-end.

Asset-class return outlooks

Our 10-year, annualized, nominal return projections, as of June 30, 2021, are shown below. Please note that the figures are based on a 1.0-point range around the rounded 50th percentile of the distribution of return outcomes for equities and a 0.5-point range around the rounded 50th percentile for fixed income.

Equities	Return projection	Median volatility
U.S. equities	2.4%–4.3%	16.7%
U.S. value	2.9%–4.9%	18.9%
U.S. growth	–0.6%–1.4%	17.7%
U.S. large-cap	2.4%–4.2%	16.3%
U.S. small-cap	2.1%–4.1%	21.8%
U.S. real estate investment trusts	2.2%–4.2%	19.3%
Global equities ex-U.S. (unhedged)	5.1%–7.1%	18.7%
Fixed income	Return projection	Median volatility
U.S. aggregate bonds	1.3%–2.3%	4.5%
U.S. Treasury bonds	1.1%–2.1%	4.6%
U.S. credit bonds	1.5%–2.5%	4.6%
U.S. high-yield corporate bonds	1.9%–2.9%	10.4%
U.S. Treasury Inflation-Protected Securities	0.9%–1.9%	7.0%
U.S. cash	1.2%–2.2%	1.2%
Global bonds ex-U.S. (hedged)	1.2%–2.2%	3.8%
Emerging markets sovereign	1.9%–2.9%	10.2%
U.S. inflation	1.4%–2.4%	2.3%

These probabilistic return assumptions depend on current market conditions and, as such, may change over time.

IMPORTANT: The projections or 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. Distribution of return outcomes from the VCMM are derived from 10,000 simulations for each modeled asset class. Simulations are as of June 30, 2021. Results from the model may vary with each use and over time. For more information, see the Notes section.

Source: Vanguard Investment Strategy Group.

U.S economic growth holds up, while the outlook for China dips

United States

We lowered our third-quarter and, thus, full-year growth forecasts for the United States in response to the consumer supply constraints and the resurgence of COVID-19 owing to the spread of the Delta variant.

• The current slowdown coupled with a weaker-than-expected annual growth rate of 6.6% in the second quarter led us to revise our forecast for full-year growth downward, to around 6%, from our previous forecast of around 7.5%.
• We still expect fourth-quarter growth at an annual rate of around 5.5% and estimate GDP growth for all of 2022 will be around 3.5% to 4.0%.
• Under our revised forecasts, the United States would reach its pre-pandemic growth trend in the first quarter of 2022, rather than the fourth quarter of 2021.

Euro area

Daily new cases of COVID-19 have fallen recently in previous hot spots such as Spain and France, and hospitalizations appear to have peaked across the euro area. We maintain our view of full-year GDP growth of around 5%.

• On September 9, the European Central Bank revised its full-year euro area growth forecast from 4.6% to 5.0%, bringing its view in line with ours.
• Gross domestic product grew by a seasonally adjusted 2.2% in the second quarter compared with the first quarter, according to the most recent estimate by Eurostat.

China

Risks to economic growth remain tilted to the downside in China, despite the most recent outbreak of the COVID-19 Delta variant appearing to be under control. Given the highly contagious nature of the Delta variant and the relatively low efficacy of China’s vaccine, the risk of further outbreaks and lockdowns remains elevated.

• We continue to anticipate full-year economic growth in China at just below 8.5%.
• Chinese government data released September 15 showed slowing growth in both industrial production and retail sales.
• August export data were stronger than expected, helped by a temporary diversion of orders from Southeast Asian nations dealing with COVID-19 and resilient demand from developed markets for tech-related and capital goods.

Emerging markets

COVID-19 continues to have a divergent story in emerging markets. Emerging Asia, which we had anticipated at the start of the year would be the strongest emerging region for growth, has been beset by low vaccination rates and—given its many “zero-COVID” lockdowns—a low rate of infection-acquired immunity as well. The region has struggled with rising case counts.

• Latin America, which had been hit hard by the coronavirus around midyear, has continued to see case counts fall in recent weeks.
• We’re watching for the degree to which some of the world’s more developed emerging markets, such as South Korea, might be able to use their relatively higher vaccination rates to move away from zero-COVID lockdown approaches, which can weigh on growth.

The Feds asset-purchase tapering may begin sooner

Minutes of the Federal Open Market Committee’s (FOMC’s) July 27–28 meeting suggest the Federal Reserve plans to start to reduce the pace of its asset purchases this year. We’ve changed our estimate of when such asset-purchase tapering may begin from the first quarter of 2022 to the fourth quarter of 2021.

• We believe the Fed will want to see further strong labor market reports before formalizing a tapering plan. (A strong jobs report for July was followed by a relatively weak August report.)
• The July meeting minutes show that while most FOMC members believe the Fed has met its price-stability goal for initiating the removal of its policy recommendations, it hasn’t met its maximum-employment goal.

Inflation may not settle down as soon as expected

The inflation environment is likely to be more volatile in coming years than we’ve come to expect recently. Vanguard’s view is that the consensus is too sanguine about inflation in the United States settling into its pre-pandemic trend of 2.0% in 2022.

• In our base case, we anticipate that the core Consumer Price Index (CPI)—which excludes volatile food and energy prices—will come in around or above 3% through the first quarter of 2022, settle back just below 2% for some time, and end 2022 above the Federal Reserve’s target of 2%.
• Risks for higher inflation include the potential that current supply-and-demand dislocations could prove less transitory than expected and that inflation expectations could become dislodged and put upward pressure on actual inflation.
• Globally, prices have risen as demand has returned to normal levels amid supply shortages in goods, services, and even labor.
• We foresee core inflation exceeding central bank targets in the United States and the United Kingdom in the months ahead and settling below the targets in China and the euro area.

Resurgent demand and supply constraints push up process

Employment outlook should brighten

Job creation in the U.S. paused in July, with growth in job creation slowing to a seven-month low of 235,000. Vanguard believes the number belies the strength of the U.S. labor market.

• Vanguard continues to foresee the unemployment rate falling toward the mid-4% range by year-end.
• Provided the rate of new COVID-19 Delta variant cases doesn’t require interventions that could change the trajectory of the economic recovery, we foresee a number of forces aligning that should spur a strong upswing in employment in the coming months.
• Three-month average job growth stands at 750,000, and we anticipate average monthly job growth of around 700,000 for the rest of the year given businesses’ significant need for labor and the expiration of pandemic-related unemployment insurance benefits.

Notes:

• All investing is subject to risk, including possible loss of principal.
• Diversification does not ensure a profit or protect against loss.
• Investments in bonds are subject to interest rate, credit, and inflation risk.
• Investments in stocks or bonds issued by non-U.S. companies are subject to risks including country/regional risk and currency risk. These risks are especially high in emerging markets.
• Funds that concentrate on a relatively narrow market sector face the risk of higher share-price volatility.
• 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 U.S. 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.

Disclosure:

All information has been obtained from sources believed to be reliable, but its accuracy is not guaranteed. There is no representation or warranty as to the current accuracy, reliability, or completeness of, nor liability for, decisions based on such information and it should not be relied on as such.