Economic and market outlook

Our return forecasts and portfolio perspectives

June 26, 2023

Equity markets around the world generally have rallied strongly—with the notable exception of China, the dominant emerging market by total value—since we issued Vanguard economic and market outlook for 2023: Beating back inflation. For most investors around the world, the gains have reduced the expected returns of global equities excluding local markets, as shown below. 

“Corporate profits have mostly fallen in the last several months,” said Kevin DiCiurcio, head of development for the Vanguard Capital Markets Model® (VCMM). “But investors anticipated greater profit declines. It appears that hopes of a soft economic landing—a deceleration that does not end in recession but helps to tame inflation—have made investors comfortable with higher equity valuations.”

Vanguard continues to expect recession in most developed and emerging economies.

For U.S. dollar-based investors, developed markets outside the United States have been rewarding in recent months, comfortably outpacing the U.S. market, which in turn outpaced emerging equity markets. Gains in Japanese shares and declines in the value of the dollar versus other major currencies boosted developed-market returns. 

Bond markets worldwide also have largely recorded solid gains, if only in nominal—not inflation-adjusted—terms, since late2022. Relative to our initial forecast, expected returns generally declined slightly.

Bucking the global trend of strong equity and solid bond performance, markets in the United Kingdom struggled in the first half of 2023. Falling equity valuations and rising bond yields boosted our expectations for 10-year annualized returns in British pounds. Widening interest rate differentials between the U.K. and the United States improved the outlook for global equities and bonds excluding British issues.

Across all equity and bond markets, expected returns remain far above their levels at year-end 2021, after a dismal 2022 pushed them up markedly.

Our current forecasts are derived from a May 31, 2023, running of the VCMM, compared with the model’s output from December 31, 2021, and December 31, 2022. Forecasts are from the perspective of local investors in local currencies.

U.S. dollar

A bar chart shows how Vanguard’s forecasts of asset-class returns, in U.S. dollars, have evolved in the last 18 months. Specifically, the chart shows return forecasts, in ranges, for four asset classes as of year-end 2021, year-end 2022, and midyear 2023. The forecasts—from oldest to current—are: for U.S. equities, 2% to 4%, rising to 4.4% to 6.4%, and then falling to 4.1% to 6.1%; for global equities excluding U.S. shares, unhedged, 5.1% to 7.1%, rising to 6.7% to 8.7%, and then falling to 6.5% to 8.5%; for U.S. aggregate bonds, 1.5% to 2.5%, rising to 4% to 5%, and then falling to 3.8% to 4.8%; and for global bonds excluding U.S. issues, hedged, 1.3% to 2.3%, rising to 3.9% to 4.9%, and then falling to 3.7% to 4.7%.

Canadian dollar

A bar chart shows how Vanguard’s forecasts of asset-class returns, in Canadian dollars, have evolved in the last 18 months. Specifically, the chart shows return forecasts, in ranges, for four asset classes as of year-end 2021, year-end 2022, and midyear 2023. The forecasts—from oldest to current—are: for Canadian equities, 2.9% to 4.9%, rising to 4.6% to 6.6%, and then rising again to 4.9% to 6.9%; for global equities excluding Canadian shares, unhedged, 3% to 5%, rising to 4.7% to 6.7%, and then falling to 4.5% to 6.5%; for Canadian aggregate bonds, 1.4% to 2.4%, rising to 3.4% to 4.4%, and then falling to 3.3% to 4.3%; and for global bonds excluding Canadian issues, hedged, 1.1% to 2.1%, rising to 3.2% to 4.2%, and then falling to 3.1% to 4.1%.

Euro

A bar chart shows how Vanguard’s forecasts of asset-class returns, in euros, have evolved in the last 18 months. Specifically, the chart shows return forecasts, in ranges, for four asset classes as of year-end 2021, year-end 2022, and midyear 2023. The forecasts—from oldest to current—are: for euro area equities, 2.4% to 4.4%, rising to 4.1% to 6.1%, and then falling to 3.8% to 5.8%; for global equities excluding euro area shares, unhedged, 1.2% to 3.2%, rising to 3.9% to 5.9%, and then falling to 3.5% to 5.5%; for euro area aggregate bonds, –0.5% to 0.5%, rising to 2.6% to 3.6%, and then falling to 2.3% to 3.3%; and for global bonds excluding euro area issues, hedged, –0.5% to 0.5%, rising to 2.5% to 3.5%, and then falling to 2.3% to 3.3%.

British pound

A bar chart shows how Vanguard’s forecasts of asset-class returns, in British pounds, have evolved in the last 18 months. Specifically, the chart shows return forecasts, in ranges, for four asset classes as of year-end 2021, year-end 2022, and midyear 2023. The forecasts—from oldest to current—are: for U.K. equities, 4.2% to 6.2%, holding steady at that range at year-end 2022, and then rising to 4.5% to 6.5%; for global equities excluding U.K. shares, unhedged, 2.5% to 4.5%, rising to 5.3% to 7.3%, and then rising again, to 5.8% to 7.8%; for U.K. aggregate bonds, 0.8% to 1.8%, rising to 4.2% to 5.2%, and then rising again, to 4.3% to 5.3%; and for global bonds excluding U.K. issues, hedged, 0.8% to 1.8%, rising to 3.8% to 4.8%, and then rising again, to 4.3% to 5.3%.

Chinese yuan

A bar chart shows how Vanguard’s forecasts of asset-class returns, in Chinese yuan, have evolved in the last 18 months. Specifically, the chart shows return forecasts, in ranges, for three asset classes as of year-end 2021, year-end 2022, and midyear 2023. The forecasts—from oldest to current—are: for China equities, 5.4% to 7.4%, rising to 7.3% to 9.3%, and then rising again, to 7.5% to 9.5%; for global equities excluding China shares, unhedged, 3.2% to 5.2%, rising to 5.3% to 7.3%, and falling to 5% to 7%; and for China aggregate bonds, 2.5% to 3.5%, holding steady at that range at year-end 2022, and then falling to 2.4% to 3.4%.

Australian dollar

A bar chart shows how Vanguard’s forecasts of asset-class returns, in Australian dollars, have evolved in the last 18 months. Specifically, the chart shows return forecasts, in ranges, for four asset classes as of year-end 2021, year-end 2022, and midyear 2023. The forecasts—from oldest to current—are: for Australian equities, 3.3% to 5.3%, rising to 4% to 6%, and then rising again to 4.3% to 6.3%; for global equities excluding Australian shares, unhedged, 3.3% to 5.3%, rising to 5.4% to 7.4%, and then falling to 5% to 7%; for Australian aggregate bonds, 1.3% to 2.3%, rising to 3.8% to 4.8%, and then falling to 3.4% to 4.4%; and for global bonds excluding Australian issues, hedged, 1.6% to 2.6%, rising to 4% to 5%, and then falling to 3.6% to 4.6%.

Mexican peso

A bar chart shows how Vanguard’s forecasts of asset-class returns, in Australian dollars, have evolved in the last 18 months. Specifically, the chart shows return forecasts, in ranges, for five asset classes as of year-end 2021, year-end 2022, and midyear 2023. The forecasts—from oldest to current—are: for Mexico equities, 5.5% to 7.5%, rising to 7% to 9%, and then falling to 6.9% to 8.9%; for U.S. equities, unhedged, 6.7% to 8.7%, rising to 7.8% to 9.8%, and falling to 7.7% to 9.7%; for global excluding U.S. developed market equities, unhedged, 10.1% to 12.1%, falling to 9.9% to 11.9%, and holding steady at that range at midyear 2023; for Mexico sovereign bonds, 8.1% to 9.1%, rising to 10.4% to 11.4%, and holding steady at that range at midyear 2023; and for global bonds excluding Mexico issues, hedged, 7.4% to 8.4%, rising to 9.3% to 10.3%, and then falling to 9.2% to 10.2%.

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. Distribution of return outcomes from the VCMM are derived from 10,000 simulations for each modeled asset class. Simulations are as of December 31, 2021; December 31, 2022; and May 31, 2023. Results from the model may vary with each use and over time. For more information, please see the Notes section below.

Notes: Figures are based on a 2-point range around the 50th percentile of the distribution of return outcomes for equities and a 1-point range around the 50th percentile for fixed income.

Source: Vanguard.

Bonds remain foremost in our time-varying portfolio allocation

Our time-varying asset allocation (TVAA) methodology uses our outlook for the financial markets over intermediate horizons, such as 10 years, to maximize expected portfolio returns for given levels of expected risk. TVAA can help an investor who, for example, targets a certain level of return or portfolio payout to fund a required level of spending. Achieving a target payout through changing market conditions may require adjusting the asset allocation over time.

It’s important to note that our time-varying asset allocation is not for everyone; it’s intended for investors willing to accept the risk that our models may not accurately anticipate economic and market dynamics. We recommend that investors obtain professional advice before implementing time-varying portfolios.

The Vanguard Asset Allocation Model (VAAM) optimizes the TVAA portfolio. Inputs to VAAM come from the Vanguard Capital Markets Model, which produces the 10-year market outlooks we publish regularly—outlooks that focus on the central tendencies produced by the model. In assessing potential time-varying asset allocations, VAAM looks beyond central tendencies to the extremes—the expected outcomes at VCMM’s 5th and 95th percentiles.

As shown in the charts below, the optimal equity allocation from a U.S. investor’s perspective has declined over the last two years. The decline reflects the partial recovery of equity valuations from bear market lows and the considerable rise in interest rates. 

A series of four pie charts show the asset mix of our time-varying asset allocation model in, first, its steady state and then in May 2021, May 2022, and May 2023. Each asset mix includes U.S. equities, international equities, U.S. bonds, and international bonds. Projected portfolio statistics beneath each pie chart present the annualized returns, annualized volatility, and annualized Sharpe ratio of the asset mix. From the steady state to the most recent asset mix, U.S. equity exposure declines from 36% to 22% to 19% and finally to 18%. International equity exposure begins at 24%, rises to 33%, and then declines to 28% and finally to 27%. U.S. bond exposure starts at 28%, remains 28% in May 2021, and then rises to 32% and ends at 33%. International bond exposure increases from 12% to 18% to 21% and finally to 22%. Following are the projected portfolio statistics: For the steady-state asset mix, 5.8% annualized returns, 9.7% annualized volatility, and 0.26 annualized Sharpe ratio; for the May 2021 asset mix, 6.1% annualized returns, 9% annualized volatility, and 0.3 annualized Sharpe ratio; for the May 2022 asset mix, 5.8% annualized returns, 7.7% annualized volatility, and 0.31 annualized Sharpe ratio; and for the May 2023 asset mix, 5.8% annualized returns, 7.4% annualized volatility, and 0.31 annualized Sharpe ratio.

IMPORTANT: The projections or 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 the VCMM are derived from 10,000 simulations for each modeled asset class. Simulations are as of May 31, 2021; May 31, 2022; and May 31, 2023. Results from the model may vary with each use and over time. 

Notes: The charts show the optimal allocation to U.S. and international stocks and bonds for a hypothetical investor looking to maximize risk-adjusted returns. Allocations are based on the VCMM forecast at the end of that month, which takes into consideration initial market and economic conditions at that point in time and produces a forecast for the subsequent 10 years. Optimization is done using the Vanguard Asset Allocation Model (VAAM), which aims to capture the traditional risk/return trade-offs for beta, factors, and alpha with investors' attitudes toward those risks. The Sharpe ratio is a measure of return above the risk-free rate that adjusts for volatility. A higher Sharpe ratio indicates a higher expected risk-adjusted return. The “benchmark” portfolio is a standard 60/40 stock/bond portfolio with equity home country bias of 60% and bond home country bias of 70%. Home country bias is the percentage of assets in the portfolio that are from a given investor’s region (in this case, U.S. securities for a U.S. investor). U.S. equities are represented by the Dow Jones U.S. Total Stock Market Index (formerly known as the Dow Jones Wilshire 5000) through April 22, 2005; the MSCI US Broad Market Index through June 2, 2013; and the CRSP US Total Market Index thereafter. International equities are represented by the Total International Composite Index through August 31, 2006; the MSCI EAFE + Emerging Markets Index through December 15, 2010; the MSCI ACWI ex USA IMI Index through June 2, 2013; and the FTSE Global All Cap ex US Index thereafter. International bonds are represented by the Bloomberg Global Aggregate Index ex USD, and U.S. bonds are represented by the Bloomberg U.S. Aggregate Bond Index. Portfolio weights may not total 100% because of rounding.

Source: Vanguard calculations, based on data as of May 31, 2021; May 31, 2022; and May 31, 2023.

Notes: 

All investing is subject to risk, including the possible loss of the money you invest. Diversification does not ensure a profit or protect against a loss in a declining market. Be aware that fluctuations in the financial markets and other factors may cause declines in the value of your account. There is no guarantee that any particular asset allocation or mix of funds will meet your investment objectives or provide you with a given level of income. Past performance is no guarantee of future results.

Investments in stocks and bonds issued by non-U.S. companies are subject to risks including country/regional risk and currency risk. These risks are especially high in emerging markets.

Bond funds are subject to the risk that an issuer will fail to make payments on time, and that bond prices will decline because of rising interest rates or negative perceptions of an issuer’s ability to make payments.

About the Vanguard Capital Markets Model

IMPORTANT: The projections and 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 Investment Strategy Group. The model forecasts distributions of future returns for a wide array of broad asset classes. Those asset classes include U.S. and international equity markets, several maturities of the U.S. Treasury and corporate fixed income markets, international fixed income markets, U.S. 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. 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 analyzing 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 recognize 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.

Indexes used in Vanguard Capital Markets Model simulations

The long-term returns of our hypothetical portfolios are based on data for the appropriate market indexes as of December 31, 2021; December 31, 2022; and May 31, 2023. We chose these benchmarks to provide the most complete history possible, and we apportioned the global allocations to align with Vanguard’s guidance in constructing diversified portfolios. Asset classes and their representative forecast indexes are as follows:

U.S. equities: MSCI US Broad Market Index.
Global ex-U.S. equities: MSCI All Country World ex USA Index.
U.S. aggregate bonds: Bloomberg U.S. Aggregate Bond Index.
Global ex-U.S. bonds: Bloomberg Global Aggregate ex-USD Index.

Canadian equities: MSCI Canada Total Return Index.
Global ex-Canada equities: MSCI All Country World Index ex-Canada in CAD.
Canadian aggregate bonds: Bloomberg Canadian Issues 300MM Index.
Global ex-Canada bonds: Bloomberg Global Aggregate ex-Canada Index (CAD Hedged).

UK equities: Bloomberg Equity Gilt Study from 1900 to 1964, Thomson Reuters Datastream UK Market Index 1965 to 1969; MSCI UK thereafter.
Global ex-UK equities: S&P 90 Index from January 1926 through March 3, 1957; S&P 500 Index from March 4, 1957 through 1969; MSCI World ex UK Index from 1970 through 1987; MSCI AC World ex UK thereafter.
UK aggregate bonds: Bloomberg Sterling Aggregate Bond Index.
Global ex-UK bonds: Standard & Poor’s S&P 90 Index from January 1926 through March 3, 1957; S&P 500 Index from March 4, 1957 through 1969; MSCI World ex UK Index from 1970 through 1987; MSCI AC World ex UK thereafter.

Euro area equities: MSCI European Economic and Monetary Union (EMU) Index.
Global ex-euro area equities: MSCI AC World ex EMU Index.
Euro area aggregate bonds: Bloomberg Euro-Aggregate Bond Index.
Global ex-euro area bonds: Bloomberg Global Aggregate ex Euro Index.

Australian equities: MSCI Australia Index.
Global ex-Australia equities: MSCI All Country World ex-Australia Index.
Australian bonds: Bloomberg Australian Aggregate Bond Index.
Global ex-Australia bonds: Bloomberg Global Aggregate ex-AUS Bond Index.

China equities: MSCI China A Onshore Index.
Global equities ex-China: MSCI All Country World ex China Index.
China aggregate bonds: ChinaBond Aggregate Index.

Mexico equities: MSCI Mexico Index.
Global ex-U.S. developed market equities: MSCI World ex US Index.
Mexico sovereign bonds: S&P/BMV Sovereign MBONOS Bond Index.
Global bonds ex-Mexico: Bloomberg Global Aggregate Index.

A closer look

Joe Davis

Our midyear 2023 outlook

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