With the second half of the year firmly underway, our experts have revisted their long-term forecasts for shares and bonds¹.

We wrote about their projections back in December, including their outlook for shares and outlook for bonds. 

Since then, the rally in global share prices has continued, driven by the US stock market in particular. 

This has resulted in share price valuations (a measure of how well a company’s share price is justified by important measures such as its earnings) becoming more ‘stretched’. In simple terms, shares seem more expensive than they should be. 

In contrast, bonds look ‘undervalued’ – or less expensive than they should be.

But what does this mean for the long-term outlook for shares and bonds? And how should investors react?

How valuations have changed this year

The chart below shows which areas of the market we think are over- or undervalued, as at May 2024 and compared with December 2023. To do this, we take a measure of company share prices relative to their earnings². We then compare this with our own estimate of what is a ‘fair’ value for share prices, based on things like interest rates and inflation.

The chart shows that the most stretched shares are in the US. As a result, this has slightly reduced our forecast returns for global shares for UK investors³. We now expect the total return from global ex-UK shares to be around 4.4%-6.4% over the next 10 years on an annualised⁴ basis. This is down from our previous forecast of 4.6%-6.6% at the end of December. 

Elsewhere, UK and euro area shares have become more stretched since December, whereas emerging market shares appear more undervalued. 

Even though UK shares are currently looking more stretched, our long-term forecast for UK shares has still improved slightly since the end of last year. We forecast that they will return 5.0%-7.0% annualised over the next decade, up from our forecast of 4.8% to 6.8% at the end of December.

Bond valuations, meanwhile, have fallen and the long-term outlook has improved. We expect annualised returns from UK bonds of 4.2%-5.2% over the next 10 years, up from 3.5%-4.5% in our December forecast. For global bonds ex-UK, we forecast annualised returns of 4.4%-5.4% over the next decade, up from 3.6%-4.6% in December.

Valuations for shares and bonds across different 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, the U.S. Bureau of Labor Statistics, the Federal Reserve Board and Refinitiv, as at 31 May 2024.

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 31 May 2024 and 31 December 2023. Results from the model may vary with each use and over time.

What does this mean for a global portfolio?

Although return expectations can vary across different regions or sectors, it’s 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 for some time, often years. Similarly, a region or sector may remain overvalued for some time.

This is one of the key benefits of having a global portfolio that spreads your money across regions and sectors. It saves you from trying to time the markets, which is a strategy that rarely pays off. It also means you’re 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 help you to avoid chasing ‘hot’ sectors that have already had a strong run. However, valuations aren’t good indicators of short-term returns, which means adjusting your portfolio based solely on valuations could prove detrimental. Our valuation measures are long term in nature, which means over- or undervaluation should not, in itself, mean investors should take action in the short term. 

What does this mean for me?

The proportion of shares and bonds in your portfolio should depend on your goals and attitude to risk. 

Someone with longer-term goals (such as saving for retirement) and a higher attitude to risk might hold a higher proportion in shares than someone with shorter-term goals or a lower attitude to risk. This is because shares have historically offered higher returns than bonds over the long term, albeit with greater volatility (or swings in prices) along the way. Bonds have historically offered lower but more stable returns than shares.

It’s also important to diversify across different sectors and regions. Over time, underperformance in any one area can be offset by better performance elsewhere. Having a balanced portfolio is one of our key principles for investment success.

¹ 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.

² The cyclically adjusted price/earnings ratio or CAPE. CAPE reflects real share prices and 10-year average historical real earnings.

³ British pound (GBP) investors.

⁴ 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).

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. 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 US and international equity markets, several maturities of the U.S. Treasury and corporate fixed income markets, international fixed income markets, US 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.

The primary value of the VCMM is in its application to analysing potential client portfolios. VCMM asset-class forecasts—comprising distributions of expected returns, volatilities, and correlations—are key to the evaluation of potential downside risks, various risk–return trade-offs, and the diversification benefits of various asset classes. Although central tendencies are generated in any return distribution, Vanguard stresses that focusing on the full range of potential outcomes for the assets considered, such as the data presented in this paper, is the most effective way to use VCMM output.

The VCMM seeks to represent the uncertainty in the forecast by generating a wide range of potential outcomes. It is important to recognise that the VCMM does not impose “normality” on the return distributions, but rather is influenced by the so-called fat tails and skewness in the empirical distribution of modeled asset-class returns. Within the range of outcomes, individual experiences can be quite different, underscoring the varied nature of potential future paths. Indeed, this is a key reason why we approach asset-return outlooks in a distributional framework.

Investment risk information

The value of investments, and the income from them, may fall or rise and investors may get back less than they invested.

Any projections should be regarded as hypothetical in nature and do not reflect or guarantee future results.

Important information

Vanguard Asset Management Limited only gives information on products and services and does not give investment advice based on individual circumstances. If you have any questions related to your investment decision or the suitability or appropriateness for you of the product[s] described, please contact your financial adviser.

This article is designed for use by, and is directed only at persons resident in the UK.

The information contained herein is not to be regarded as an offer to buy or sell or the solicitation of any offer to buy or sell securities in any jurisdiction where such an offer or solicitation is against the law, or to anyone to whom it is unlawful to make such an offer or solicitation, or if the person making the offer or solicitation is not qualified to do so. The information does not constitute legal, tax, or investment advice. You must not, therefore, rely on it when making any investment decisions.

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