US stocks are predicted to have a lackluster performance in the coming years, according to Greg Davis, the chief investment officer at Vanguard. In an interview with CNBC, Davis estimated that the returns for stocks would be below average, averaging between 4.7% and 6.7% over 2024 and the following years. This is significantly lower than the previous returns of the S&P 500, which were around 9% to 10%.
There are two main reasons why US stocks are expected to underperform. First, valuations in the stock market are currently too high. Davis explained that much of the recent growth in US stocks can be attributed to valuation expansion, but this trend cannot continue indefinitely. This is especially true as the market exits the period known as the Great Moderation, which was characterized by low interest rates, loose financial conditions, and steady stock returns. Additionally, US stocks have outperformed international stocks by approximately 8 percentage points over the last decade, a trend that is unlikely to continue. The Federal Reserve has raised interest rates aggressively in the past year and a half to combat inflation, which has already caused stocks to decline in 2022. Vanguard predicts that US stocks will yield around 5% annually in the coming years, while international stocks are expected to yield between 7% and 9%.
The second reason for the expected underperformance is the low risk premium in the US stock market. The equity risk premium, which measures the excess return of stocks over the risk-free rate, is currently around 2 percentage points lower than the long-term average. This indicates that US bonds are becoming a more attractive investment option, especially with the yield on the 10-year Treasury hovering close to 5% in recent months. In contrast, international markets have a higher equity risk premium, making stocks more appealing than bonds.
Investors have already started to take note of these factors, as weekly flows in US equities have turned slightly negative over the past three weeks, as reported by Bank of America. This suggests that investors are becoming cautious about the outlook for the equity market. Some market veterans have also raised concerns about the economy, pointing to signs of weakness beneath the surface, which could potentially indicate an upcoming recession.
Overall, the outlook for US stocks is predicted to be disappointing in the next few years, with high valuations and a low risk premium contributing to lower returns. Investors are advised to consider alternative investment options and remain cautious in their approach to the stock market.
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