Given below-average inflation, low interest rates and elevated stock valuations, stocks and bonds are expected to fall short of historical annualized returns over the next decade.
That's according to a new market outlook from Charles Schwab, one of the leading online brokerages, which predicts the annual expected return for large-cap, U.S.-based stocks to be 6.5% from 2018 through 2027. That compares with an annualized return of 10.5% from 1970 to 2017. The Charles Schwab Corporation (SCHW) also expects small-cap stocks, international large-cap stocks, core bond and cash investments to underperform historical averages over the next 10 years. International large-cap stocks are the outlier, with the brokerage projecting that they will see 7.2% growth during the next decade, outshining U.S. large-cap stocks.
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"The reduced outlook follows an extended period of double-digit returns for some asset classes," wrote Veerapan Perianan, a senior quantitative analyst for Charles Schwab Investment Advisory, in the report. "As such, now may be a good time for investors to review, and consider resetting, long-term financial goals to ensure that they are based on projections grounded in disciplined methodology and not historical averages."
According to the San Francisco-based brokerage, while investors and Wall Street are paying close attention to inflation, worrying that a rising rate will prompt the Federal Reserve to raise interest rates more aggressively this year, inflation is actually at a low rate, which can have more of a negative impact on stock returns over the long run. Schwab said that, from 1970 through 2017, inflation averaged 4% annually, while it is forecast to be just 2.2% from 2018 through 2027. Low inflation not only implies that bond yields will remain low, but it has historically meant low returns for stocks, Perianan said.
Another factor that will weigh on returns, according to Perianan, is the elevated valuations of stocks, many of which climbed higher than their earnings growth last year. That resulted in lofty valuations. And while that is coming back in line a bit thanks to the tax reform bill that lowered the corporate tax rate, the Schwab analyst said that it would be good to see further evidence of earnings growth to back the higher returns of stocks going forward.
As for interest rates, while the Fed signaled that it could raise rates at least twice this year, Perianan said that the environment of low real rates is likely to continue, which will affect the growth of stocks during the next 10 years. "Low yields mean investors earn less from the fixed-income portion of their portfolios. Stock returns tend to be higher than bond yields due to the relatively greater risk in holding stocks. When bond yields are lower, stock returns tend to be lower," wrote Perianan.