Vanguard 2024 Outlook: Higher Rates Boost 60/40 Portfolio Prospects

Vanguard Group's 2024 outlook report highlights a renewed strength in the traditional 60/40 stocks and bonds portfolio, due to rising interest rates boosting fixed-income returns. The report indicates a significant increase in the likelihood of achieving a 10-year annualized return of at least 7%, from 8% in 2021 to 40% today.

 

The shift to higher interest rates has been challenging, causing historic losses in bonds and volatility in stocks. However, Vanguard sees this as a pivotal economic and financial development, with long-term implications beyond the current business cycle. The Federal Reserve's aggressive interest rate hikes, reaching a 22-year high of 5.25% to 5.5%, were aimed at controlling inflation. Vanguard anticipates a sustained higher-rate environment even after the Fed reduces rates, marking an end to the era of zero interest rates.

 

This new era is seen as a return to sound money, influencing government fiscal sustainability, and promoting savings while limiting borrowing among households and businesses. Consequently, bonds are regaining appeal. Vanguard now expects U.S. bonds to yield nominal annualized returns of 4.8% to 5.8% over the next decade, a significant increase from the 1.5% to 2.5% forecast before the rate hikes.

 

Despite the initial impact of rising rates in 2022, Vanguard believes that higher levels will be beneficial in the long run. The income component of bond returns is expected to compensate for recent capital losses, leading to higher bond portfolio values by the decade's end. The Vanguard Total Bond Market ETF BND has already shown improvement, with a 2.9% total return this year, a stark contrast to last year's 13.1% loss.

 

Vanguard views U.S. aggregate bonds and intermediate Treasuries as fairly valued, with the Vanguard Intermediate-Term Treasury ETF VGIT gaining 2% this year, recovering from a 10.5% loss in 2022.

 

In contrast, U.S. equities, particularly growth stocks, are considered more overvalued than a year ago. Higher interest rates are expected to depress asset price valuations and squeeze corporate profit margins. Vanguard has slightly lowered its U.S. equity return expectations for the next decade, with a more favorable outlook for value and small-capitalization stocks.

 

Regarding inflation, the Federal Reserve is expected to ease its policy in the second half of 2024, aiming to reduce rates below 4% by the end of the year. Despite progress in controlling inflation and strong economic growth, Vanguard believes achieving a 2% inflation rate without demand weakness will be challenging, describing it as the 'last mile' in inflation control.