The US market is expected to underperform its international peers during the next 10 years, Vanguard economists have said, as value stocks are projected to overtake growth.
Qian Wang, chief economist, Asia-Pacific and global head of Vanguard Capital Markets Model noted for the next decade, she is expecting higher return from value stocks over growth, despite the contrary being true as of late.
Research from Vanguard has shown that the underperformance of value factor can be justified by downward trending long-term inflation levels and the lack of acceleration in earnings growth during the last 10 years.
“Think about that, lower inflation levels are more beneficial to the growth factor of growth stocks, because of the longer term nature of their expected dividends,” Dr Wang said.
“When the future cash flow is discounted to present, then the present value will be higher when the discount rate is lower. Meanwhile, in the low earnings growth environment, investors are also willing to pay a higher price for growth as well.”
However Vanguard has still determined that value stocks are significantly undervalued.
In the future, if inflation and earnings start to recover, alongside risk appetite, then value stocks could start to overtake growth.
Vanguard economists are anticipating returns from value will be higher than growth by almost a full percentage point, every year in the coming decade. The implications would be evident in the relative performance of markets down the road – including the US, which is skewed towards growth.
“For example… the US market will underperform the rest of the world, in the next 10 years,” Dr Wang said.
“In our VCMM model, we are seeing that the US is likely to generate about 5 per cent return every year, but then the rest of the world is likely to generate about 6.1 per cent return, annually in the next 10 years.”
Beatrice Yeo, economist for Vanguard Australia added Australian equities are expected to have slightly higher returns than those in the US.
“On an annualised basis, we’re expecting the media return for Aussie equities to be around 50 basis points higher than that of global equities, just given more reasonable valuations,” she said.
“That said, I think it’s very important for investors not to construct their portfolios just solely based off these medium projections, because that will essentially ignore the diversification benefits that you’ll get from holding a global portfolio.
“I think we all saw this, the benefits of diversification play out over the most recent market cycle where you’ll find that investors holding a global equity portfolio outperform someone holding an all Australian equity portfolio by about 5 per cent in year to date terms.”
Australia, China to bounce back sooner
Vanguard’s outlook on 2021 foresees continued government support measures, though such schemes will rely heavily on health outcomes.
Should a vaccine become distributed, administered broadly and be effective, much of the economic losses from the COVID crisis could be recovered next year – but risk will remain if immunity does not rise.
Vanguard’s base-case scenario sees major economies achieving greater immunity against the virus, face-to-face social and business activity resuming, a fall in unemployment rates, higher inflation rates and pre-pandemic levels of economic output being reached.
“In countries with effective containment of the virus, such as in Australia and China, the return to normalcy may prove to be slightly faster, with Australia’s expected growth of 4 per cent likely to fuel an expected return to pre-pandemic levels by the middle of next year compared to the end of the year for countries such as the Euro Area and the UK,” Ms Yeo said.
“Recent high frequency indicators suggest the recovery has continued to gain momentum even as the JobKeeper stimulus has been tapered, and elevated household savings are expected to smooth spending even as incomes normalise.”
In the longer term, the pandemic is expected to have lingering effects, including the acceleration of working remotely and digitally, continued deglobalisation and changes in the expectations and preferences for government policy.
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Sarah Simpkins is a journalist at Momentum Media, reporting primarily on banking, financial services and wealth.
Prior to joining the team in 2018, Sarah worked in trade media and produced stories for a current affairs program on community radio.
You can contact her on [email protected]tummedia.com.au.
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