Investors in shares have had a more positive year in 2023 as global shares have rallied, driven by US growth companies (such as technology shares) in particular.

The UK stock market, by contrast, has underperformed several of its counterparts in other regions in 2023, showing the benefits of a global portfolio that is diversified across different regions and countries¹.

What is the outlook for next year?

The rally this year means that share-price valuations (which are a measure of how well a company’s share price is justified by fundamental metrics such as its earnings) are now stretched, particularly in the US.

The price of the S&P 500 index is now around 24 times the earnings generated by its constituent companies, up from around 20 at the end of last year². This is an indicator of whether a stock market is overvalued.

As a result of stretched valuations in the US and our expectation for slower earnings growth, we’ve further downgraded our expectations for returns from US shares for British pound investors.

We now expect the total return from US shares to be around 4.1%–6.1% over the next 10 years (annualised³), down from our previous forecast of 4.3%–6.3% heading into 2023.

What about outside the US?

We see an increasing likelihood of greater opportunities outside the US, where valuations are less stretched.

We forecast that UK shares will return 4.7%-6.7% annualised over the next ten years. For global ex-UK shares, we expect annualised returns of 5.1%-7.1% over the next decade.

While US shares outperformed their peers in other regions over the last 10 years, we do not expect this to continue over the next decade.

What does this mean for a global portfolio?

While expectations for returns can vary across different regions, countries or sectors, it is very difficult to correctly time when to buy or sell. Even if a region or sector is undervalued (and therefore might be expected to deliver above-average returns) it can continue to be undervalued by markets for some time; similarly, a region or sector may remain overvalued for some time.

This is one of the key benefits of having a global portfolio spread across regions and sectors. It saves you from having to time the markets and means you are exposed to a range of different regions and sectors, including those that may perform well to offset those that perform less well.

Understanding which markets may be overvalued can also help you to avoid chasing ‘hot’ sectors that have already had a strong run. However, given the long-term nature of our valuation measures and forecasts, over- or undervaluation should not, in itself, suggest a short-term action on the part of investors.

The chart below shows our estimates of which markets we think are over- or undervalued, in September this year compared with the previous September. To do this, we take a current measure of company share prices relative to their earnings⁴ and compare it to our own estimate of what is a ‘fair’ value for share prices, based on the macroeconomic environment measured through interest rates as well as inflation.

The chart shows that we consider emerging markets to be undervalued (and more so than in 2022), with US shares looking increasingly ‘stretched’ relative to what we consider to be their ‘fair’ value.

A mixed picture for shares across regions
 

Notes: A figure of 50% corresponds to valuations being equal to Vanguard’s estimate of fair value (with the yellow box representing our fair-value range). Percentage figures on either side of that range are either undervalued (green) or stretched (red). The US, UK and euro area equity valuation measure are the current cyclically adjusted price/earnings ratio (CAPE) percentile relative to our fair-value CAPE estimate for the MSCI USA Broad Market Index, MSCI UK Index and MSCI EMU Index. The global ex-UK equity and developed market ex-UK valuation measures are the market-capitalisation-weighted CAPE percentiles relative to our fair-value CAPE estimate for the MSCI USA Broad Market Index, MSCI EMU Index, MSCI Japan Index, MSCI Canada Index, MSCI Australia Index and MSCI EM Index. The valuation measure for the MSCI EM Index is only used for developed market ex-UK equity. The emerging market valuation measure is based on the percentile rank based on our fair-value model relative to the market.

Sources: Vanguard calculations, based on data from Robert Shiller’s website, at aida.wss.yale.edu/~shiller/data.htm, the U.S. Bureau of Labor Statistics, the Federal Reserve Board and Refinitiv, as at 30 September 2023.

IMPORTANT: The projections and other information generated by the VCMM 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 VCMM are derived from 10,000 simulations for each modelled asset class. Simulations as at 30 September 2023 and 30 September 2022. Results from the model may vary with each use and over time.

What does this mean for me?

The proportion of shares in your portfolio should depend on your goals and your attitude to risk. If you have longer-term goals (for example, you won’t need the money for ten years or more) and a higher appetite for risk, a higher proportion in shares may be more appropriate than if you have shorter-term goals (less than ten years away) or a lower risk tolerance.

Within the shares portion of your portfolio, it is important to diversify across different sectors and regions so that underperformance in any one area can be offset by better performance elsewhere, over time. Having a balanced portfolio is one of our key principles for investment success.

¹ The total return – including the change in the price of the index and dividend payments – of the US S&P 500 index was 16.0% from the start of the year to 7 December 2023, while it was 4.3% for the UK’s FTSE All Share index. Vanguard calculations based on data from Refinitiv, as at 7 December 2023. Returns in pounds sterling with income reinvested.

² Vanguard calculations based on data from Refinitiv, as at 7 December 2023.

³ Annualised returns show what an investor would earn over a period of time if the annual return was compounded (i.e. the investor earns a return on their return as well as the original capital).

⁴ The cyclically-adjusted price/earnings ratio or CAPE. CAPE reflects real equity prices and 10-year average historical real earnings.