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| A pedestrian talks on his mobile phone as he walks the cobblestones on Broad Street in front of the New York Stock Exchange on Mar. 14, 2008. AP Photo/Henny Ray Abrams |
Vanguard has just made a bold call that may surprise traditional investors: for the next 10 years, it recommends holding a portfolio that’s 70% bonds and only 30% stocks.
That allocation may seem unusually conservative even jarring compared to the long-standing 60/40 portfolio (60% stocks, 40% bonds). But beneath the surface, Vanguard is essentially echoing a point Wall Street has been emphasizing for months: stocks are historically expensive, and bonds are likely to outperform over the coming decade.
The Math Behind the Forecast
Vanguard’s latest projection comes down to simple valuation math. Stocks, particularly in the U.S., are priced at levels that historically signal lower forward returns. As a result, even risk-free government bonds may offer better risk-adjusted returns over the next 10 years.
This aligns closely with recent commentary from top investment banks. Goldman Sachs strategist David Kostin made headlines in October when he warned that the S&P 500 had about a 72% chance of underperforming bonds and even a 33% chance of lagging inflation through 2034.
Similarly, Morgan Stanley’s Mike Wilson told local press in December that he expects equity returns to be “flat-ish” over the next decade, especially when adjusted for inflation.
“Given where valuations are today, the returns from point A to point B over 10 years will likely be modest, if not negative in real terms,” Wilson said.
Why Valuations Matter
The centerpiece of this cautious outlook is valuation specifically, the Shiller price-to-earnings (P/E) ratio, which compares stock prices to the 10-year average of inflation-adjusted earnings.
Currently, the Shiller P/E sits in the high 30s, which has historically correlated with weak and at times, negative 10-year returns for the S&P 500. In fact, data from Invesco illustrates this relationship all the way back to 1881, showing a consistent inverse connection between high starting valuations and subsequent performance.
A more recent chart tracking the relationship since 1983 shows that initial valuations have explained roughly 78% of the index's future 10-year returns. The takeaway: when you buy stocks at elevated valuations, your long-term gains are usually diminished.
At a Shiller P/E around 37, historical outcomes suggest investors could expect anywhere from flat to just a few percent annualized returns in the coming decade.
Bonds Offer a Safer, Smarter Alternative
In contrast, the bond market presents a more stable and potentially more rewarding proposition. Vanguard forecasts average returns of 4 – 5% annually from bonds over the next 10 years. With 10-year Treasury yields currently sitting around 4.2%, investors can lock in those gains without taking on equity risk.
So the question becomes: why invest in stocks which are volatile and carry downside risk when bonds are offering similar, or even superior, long-term returns backed by the U.S. government?
This logic underpins Vanguard’s surprising recommendation. Stocks are priced for perfection. If corporate earnings merely meet expectations, markets may not reward investors. And if earnings fall short, the downside could be significant. Even if the hype around AI or other innovations proves justified, much of that optimism may already be reflected in today’s valuations.
Timing Is Everything But Not for Everyone
It’s important to note that this bearish outlook on stocks is tied to a very specific timeframe: the next 10 years. For investors with longer horizons those planning to hold assets for 20, 30, or 40 years the implications are less significant. Market cycles will come and go, and opportunities will emerge again, especially if valuations fall and returns normalize.
Still, for investors focused on returns over the next decade, Vanguard and leading Wall Street voices are delivering a clear message: this may be a time to play defense, not chase risk. Bonds are back and they just might be your best friend in the years ahead.
