It’s time once again for my annual update of expected return forecasts for stocks and bonds. Actually, it’s a bit early for my update, but I have more time now than I’ll have later this fall. My self-imposed task each year is to compile annual forecasts of long-term stock and bond returns from various investing companies and report them here.
[I also normally use this information to update my regular Mindfully Investing article on expected future returns and risks. But regular readers be warned, I probably won’t get to that until later in the month.]
While no one can forecast the future exactly, the investing goals in a mindful investing plan should be based on realistic expected future rates of return. Too often investors, including professionals, create investing plans with an overly optimistic view based on historical returns.
For example, the U.S. has one of the best long-term track records for stock returns in the world, with a historical average annual return of about 9%. But global investors are routinely expecting to exceed that average over the next five years as shown in this graph from Schroders, a British asset management firm.
Can our investing plans live up to these great expectations?
The 2020 Data
This plot shows long-term return expectations for various asset classes from a dozen or so companies that issue these forecasts each year.
All returns are on a nominal basis, meaning they are not adjusted for inflation. Most of the forecasts are estimates for the next 10 years, except for two that cover 7 and 15 years, respectively. “Non-US stocks” are mostly developed markets that exclude the U.S., although in some cases it’s unclear whether the forecasters included the U.S. in this category.
It seems that professional investors are assuming that the long-term returns for U.S. large-cap stocks will be somewhere between about -3% and 7%, well below the 9% historical average. But in case your thinking that’s a cue to switch to bonds, most professionals are still expecting that stock returns will greatly exceed bond returns.
Most of these forecasts also predict that both developed and emerging-market international stocks will outperform U.S. large-cap stocks. Conversely, U.S. government bonds are generally expected to keep pace with or slightly outperform international government bonds.
GMO’s forecasts are particularly sobering given they forecast near zero or negative returns for every asset class except non-U.S. stocks and emerging markets. However, GMO is famous for publishing perennially bearish return predictions. If we exclude GMO, the range of expected U.S. large-cap stock returns is about 2% to 7%.
The Trend
Like last year, I also wanted to look at how much the forecasts have been changing since I started tracking these forecasts in 2018. This plot compares the 2020 forecasts to the 2018 forecasts for those companies that published estimates in both years.
You were probably expecting a bar graph or something like that, so I should explain this plot. The horizontal axis shows the 2018 forecast, and the vertical axis shows the 2020 forecast. Each dot represents one company’s forecast for the asset class noted in the color legend. The black “match line” indicates where dots would fall if there was no change in the annual forecasts. When dots fall above the match line, that means the 2020 forecast was higher than the 2018 forecast—the forecast went up. When dots fall below the match line, that means the forecast went down.
Like last year, most of these companies have continued to shift their stock return expectations upward slightly from 2018. Although there are outliers in this plot, quite a few of the stock forecasts have gone up slightly as shown by the blue circle for U.S. large-cap stocks and the orange circle, which covers both non-U.S. stocks and U.S. small-cap stocks.
However, most of the bond forecasts have shifted downward slightly as shown by the green circle for U.S. bonds and the purple circle for non-U.S. bonds. Lower expected returns for bonds is not surprising given that bond yields plummeted in early 2020. This was due to the Federal Reserve reducing base interest rates to essentially zero in response to the COVID-19 pandemic. Given that bond returns come mostly from yield, historically low yields do not bode well for long-term bond investors.
The Uncertainties
It’s also important to consider the uncertainties surrounding the estimates. For example, here’s a Vanguard graph showing the range of their forecasts.
Although the Vanguard article doesn’t go into the details, based on their past work, it appears that the ranges here represent the 25th to 75th percentiles, which only covers 50% of the total forecast distribution. So, the entire range of their estimates must be much wider. For example, last year Vanguard reported the 5th and 95th percentiles ranged from less than -2% to more than 10% annual return! So, we should take all these forecasts with a large grain of salt.
An additional uncertainty with this year’s forecasts is that some of them predate the COVID-19 stock market plunge in March, and some of them came during or after the subsequent market recovery. Given that most of these forecasts factor in current stock valuations, the large fall and bounce-back in stock prices this year means the starting assumptions used across all these forecasts vary widely.
The Conclusion
Despite the market turmoils this year, overall stock return forecasts really haven’t changed that much in the past year or two. But bond returns are now expected to be considerably lower for the logical (and perhaps somewhat obvious) reason that bonds yield are close to nothing right now.
Checking these forecasts against my own investing plan tells me there’s no need to change my plan’s return assumptions, particularly since I don’t hold any bonds. But if you’re one of those optimistic investors that are hoping for annual stock returns in excess of 10% for the next decade, you might want to check your expectations and reassess your investing plan.
