Highlights
- At midyear 2024, US equity valuations remain stretched, while emerging market equities are undervalued, according to our latest research.
- In fixed income markets, UK aggregate bonds are at the low end of our fair-value range given their attractive yields, but credit spreads are tight, according to our research.
- Vanguard believes asset class valuations act as drivers of long-term returns, and have a strong tendency to revert towards average levels over multiyear periods.
At the midpoint of 2024, the broad US equity market remains richly valued. The S&P 500 Index, for example, remains well-above the top end of our estimated fair-value range based on its cyclically adjusted price/earnings ratio1. Within the US equity market, the richest valuations adorn growth stocks. Emerging market (EM) equities appear undervalued.
In fixed income, we view bond markets overall as offering good value to investors, given their attractive yield levels, with UK aggregate bonds the most attractively valued among the sub-asset classes shown. Credit spreads, on the other hand, have remained tight, with EM sovereign debt and US credit spreads now looking stretched from a valuation perspective.
To be sure, over any given investment horizon, a change in valuation is only one element of total return. For equities, the other factors are earnings growth, dividends and the currency effects of holding international shares.
Valuations are also poor indicators of short- or even intermediate-term financial market returns. For that reason, we caution investors against adjusting well-considered investment plans based solely on valuations—no matter how strong a signal they appear to be sending.
Vanguard's capital markets research team focuses on valuations as critical drivers of long-term market results. We believe they have a strong tendency to revert towards fair levels, consistent with prevailing inflation trends and interest rates, over multiyear periods and certainly over the course of decades. Such horizons are relevant to many investors, given the time they may have until they reach retirement or the years they may spend in retirement.
Potential opportunities and cautionary signals for long-term investors
Midyear 2024 asset valuations for equity and fixed income sub-asset classes and regions
Notes: The US, UK and euro area equity valuation measures are the current cyclically adjusted price/earnings ratio (CAPE) percentile relative to our fair-value CAPE estimate for the MSCI US Broad Market Index, the MSCI UK Index and the MSCI EMU Index. The global ex-UK and developed markets ex-UK valuation measures are the market-capitalisation-weighted CAPE percentiles relative to our fair-value CAPE estimate for the MSCI US 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 the global ex-UK equity valuation measure. The emerging market valuation measure is based on the percentile rank based on our fair-value model relative to the market. Factor valuations are relative to US equities as the base at the 50th percentile. Growth, value and small-cap valuation measures are all based on the percentile rank based on our fair-value model relative to the market. The large-cap valuation measure is a composite valuation measure of the style factor to US relative valuations and the current US CAPE percentile relative to its fair-value CAPE.
Aggregate bond valuation measures are market-capitalisation-weighted averages of credit and government bond valuation percentiles for the UK and global ex-UK (which in turn is a market-capitalisation-weighted average of the US, the euro area, Japan, Canada and Australia aggregate bond valuation measures that are calculated the same way). The global government bond valuation measure is based on a market-capitalisation-weighted average of the valuation measures for the UK, the US, the euro area, Japan, Canada and Australia, comparing current yields relative to the VCMM simulation of equilibrium yields in year 30 of our forecast. Credit and emerging markets sovereign debt valuation measures are based on current spreads relative to the VCMM simulation of equilibrium spreads in year 30 of our forecast, with global credit based on a market-capitalisation-weighted average of the valuation measures for the UK, the US, the euro area, Japan, Canada and Australia. The valuation percentiles are as at 31 December 2023 and 31 May 2024.
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 13 June 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 the VCMM are derived from 10,000 simulations for each modelled asset class. Simulations are as at 31 December 2023 and 31 May 2024. Results from the model may vary with each use and over time.
1 Our fair-value measure of the cyclically adjusted price/earnings (CAPE) ratio starts with the CAPE metric established by Robert Shiller of Yale University. The measure reflects the last 10 years of corporate earnings, which smooths valuations based on current prices and profits. We build upon the Shiller CAPE by estimating fair values in relation to prevailing interest and inflation rates.
Vanguard Economic and Market Outlook for 2024
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 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 US 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.
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.
Past performance is not a reliable indicator of future results.
Any projections should be regarded as hypothetical in nature and do not reflect or guarantee future results.
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