Global tariff1 discussions have been a major factor in shaping the economic outlook, but what other themes could impact investors in the coming years?
In the video below, Kevin Khang, senior international economist at Vanguard, explains that while tariffs will continue to affect economic growth and inflation2, there are two other significant trends to watch.
The first is government (or ‘fiscal’) deficits, which occur when a government spends more money than it receives in revenue in a given year. These deficits are growing at an unsustainable rate and could cause economic problems if not managed properly. The second trend is the increasing influence of artificial intelligence (AI). As AI becomes more integrated into different industries, it has the potential to boost economic performance, creating a tug of war between these two forces.
Kevin also explains that we are in a higher interest-rate environment than before the Covid-19 pandemic. This means that instead of expecting bonds3 to increase a lot in value, which they might do if interest rates were expected to keep going down, investors are more likely to earn their returns from the interest they receive and by reinvesting that interest at these higher rates.
Lastly, Kevin notes that US share (or ‘equity’) price valuations (how much investors are willing to pay for shares based on company earnings) have been stretched for several years. This is weighing on expected future returns because when prices are high it usually means lower returns going forward.
For US share prices to rise further, companies would need to keep growing their earnings significantly, or investors would need to be willing to pay more for those earnings. Both of these scenarios are unlikely.
In this environment, diversification is key. Spreading your money across different types of investments, industries and regions – rather than focusing only on US technology shares – can help to soften potential losses and manage risk.
In our 2025 outlook, we underscored our belief that a higher interest rate environment was here to stay and emphasised a growing market tension between potential economic developments and stretched US equity valuations.
Although geopolitical events bear watching, it has been the emerging risk of tariffs that has driven markets and economies.
This year, we've seen a much more dominant role of global tariff discussions playing and driving the outlook for both the US and the global economy.
They're likely to have an impact on both the growth and inflation numbers for the rest of the year.
We'll need to exercise extra judgement in discerning what is the signal and what is a noise in the numbers that are likely to be very volatile.
Beyond tariffs, we're watching what we expect will be a crucial development for markets and the economy in the years ahead.
There are two key trends that we are monitoring for not only the short term but also the longer term.
The first one is that of the rising fiscal deficits, which are on a path of an unsustainable growth.
The second trend is the extent to which productivity gains are coming from the impact of AI diffusing throughout the economy.
Our view is that between these two trends, it'll be quite the contest, tug of war if you will, to really shape the economy for the decade to come here in the US.
In Europe, a commitment for increased spending, specifically for defense, has boosted immediate economic prospects and could even have long lasting effects in the short term if they actually stay true to the plan.
That's going to have some stimulative impact on the economy, generating more growth than we otherwise would have seen.
It'll also be a kernel of homegrown productivity growth because defense spending and investment has a way of potentially generating and then increasing one's chances of finding a profound productivity growth.
We've said for some time that a higher interest rate environment than we experienced before the pandemic has arrived. That should change how investors think about bond returns.
Instead of expecting their bond holdings to appreciate aggressively in value thanks to declining interest rates, they might want to embrace a different mentality, a different expectation to earn most of the return from receiving interest and reinvesting that interest income at higher rates.
We continue to emphasise caution related to US equity prices.
US equity valuations have been stretched for a number of years, delighting investors who are already in that space, but also weighing on expected future returns because when the prices are high, generally speaking, that means lower returns.
Going forward, we believe two things would need to happen to drive US equity prices much higher. Continued impressive growth in corporate earnings and investor willingness to pay a higher price for earnings.
Either one would be considered extraordinary and both of them happening would be quite unlikely.
Putting all this together, we see a real value in diversifying beyond US tech heavy equity, blending this portfolio with stocks that are more price for resilience.
1 Trade tariffs are taxes on imported goods.
2 Inflation is the rate of increase in prices for goods and services.
3 Bonds are a type of loan issued by governments or companies, which typically pay a fixed amount of interest and return the capital at the end of the term.
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