Our investment and economic outlook, August 2026
By Vanguard
Markets and economy
Our latest forecasts for investment returns and region-by-region economic outlook
Our economic outlook for Australia
Resilient household spending may contribute to upside risk for the policy rate path
“The combination of still-elevated inflation and weak productivity makes the case for a hawkish policy stance.”
-Grant Feng, Vanguard Senior Economist
Robust household spending suggests that Australia’s current monetary policy setting may be less restrictive than the Reserve Bank of Australia (RBA) believes. Spending rose by a stronger-than-expected 0.8% in June, led by discretionary goods, lifting annual growth to a robust 6%. The softening housing market has yet to generate a meaningful negative wealth effect. Instead, households have drawn on solid income growth and accumulated savings to support consumption. This resilience is consistent with the recent strength in labour market and credit indicators and continues to support employment in labour-intensive service sectors.
Australia’s supply side remains weak, however, largely reflecting a persistent productivity challenge. GDP per hour worked fell by 0.6% quarter over quarter and was only 0.3% higher year over year. Annual productivity growth of 0.3% is broadly in line with the average pace of the past decade, but remains very low by historical standards. For the inflation outlook, what matters most is the balance between aggregate demand and aggregate supply. With sluggish productivity growth and limited supply-side momentum, a stronger pullback in demand will be needed to put the economy on a gradual disinflation path.
Meanwhile, second-quarter trimmed mean inflation inched up to 3.6% year over year, well above the RBA’s target, and may rise further in the coming months as higher energy prices pass through more broadly. These persistent inflation pressures warrant the hawkish stance in the RBA’s communication. Even while keeping rates on hold, the central bank is likely to maintain a tightening bias until there is clearer evidence that demand is slowing sufficiently to return inflation sustainably to target.
Therefore, despite an August 11 pause, the broader policy stance remains hawkish. The RBA has tightened financial conditions materially over a relatively short period, and the full effects have yet to flow through to economic activity and inflation. We continue to expect the RBA to leave the cash rate unchanged for the remainder of this year, with any further policy adjustment likely to be deferred until 2027.
Australia economic forecasts
| GDP Growth | Unemployment rate | Trimmed mean inflation | Monetary policy | |
| Year-end 2026 outlook | 1.8% | 4.3% | 3.6% | 4.35% |
| Year-end 2027 outlook | 1.7% | 4.6% | 3% | 4.35% |
Notes: GDP growth is defined as the annual change in real (inflation-adjusted) GDP in the forecast year compared with the previous year. Unemployment rate is as of December for each year. Trimmed mean inflation is the year-over-year change in the Consumer Price Index, excluding items at the extremes, as of the fourth-quarter reading for each year. Monetary policy is the Reserve Bank of Australia’s year-end cash rate target.
Source: Vanguard.
Note: All investing is subject to risk, including the possible loss of the money you invest.
Vanguard Capital Markets Model® forecasts
Our 10-year annualised nominal return and volatility forecasts are based on the 30 June 2026 running of the Vanguard Capital Markets Model®.
Australia (Australian dollar)
| Asset class | Return range | Median volatility |
| Australian equities | 4.6%–6.9% | 20.4% |
| Global ex-Australia equities (unhedged) | 5.0%–7.0% | 16.0% |
| US equities (unhedged) | 5.0%–7.0% | 17.1% |
| Australian aggregate bonds | 4.6%–5.6% | 6.4% |
| Global ex-Australia aggregate bonds (hedged) | 5.1%–6.1% | 5.4% |
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 VCMM are derived from 10,000 simulations for each modelled asset class. Simulations as of 30 June 2026. Results from the model may vary with each use and over time. For more information, please see the Notes section below.
Notes: These return assumptions depend on current market conditions and, as such, may change over time. We make our updated forecasts available at least quarterly.
Source: Vanguard.
Our economic outlook for the United States
Steady growth, stable labour, sticky inflation
“Growth remains resilient, the labour market stays healthy, and inflation continues to be elevated enough to keep the Fed on hold.”
-Josh Hirt, Vanguard Senior U.S. Economist
Growth continues to demonstrate resilience, with activity tracking at a pace consistent with an economy expanding above 2%. Business investment remains a notable source of strength, exceeding already robust expectations as firms continue to deploy capital in response to AI demand. We expect this capex cycle to remain an important contributor to growth through 2027. Consumer spending is also evolving broadly in line with expectations, supported by tax policy tailwinds and the continued benefits of elevated household wealth. Softer real income growth presents a potential headwind to consumption during the second half of the year.
The labour market remains fundamentally stable, with a broad range of indicators suggesting conditions remain close to neutral and consistent with overall health. While we continue to anticipate some moderation in payroll growth and a modest increase in unemployment during the summer months, we do not view these developments as signalling material deterioration.
Inflation continues to be distorted by measurement issues and temporary factors. However, underlying price pressures appear to be stuck in a range just below 3%. As a result, we expect the Federal Reserve to remain on hold, with risks increasingly skewed toward additional tightening should inflation fail to moderate or labour market conditions remain firm.
United States economic forecasts
| GDP Growth | Unemployment rate | Core inflation | Monetary policy | |
| Year-end 2026 outlook | 2.3% | 4.6% | 3% | 3.6% |
| Year-end 2027 outlook | 3% | 4.4% | 2.5% | 3.6% |
Notes: GDP growth is defined as the fourth-quarter-over-fourth-quarter change in real (inflation-adjusted) GDP in the forecast year compared with the previous year. Unemployment rate is as of December for each year. Core inflation is the year-over-year percentage change in the Personal Consumption Expenditures price index, excluding volatile food and energy prices, as of December for each year. Monetary policy is the rounded midpoint of the Federal Reserve’s target range for the federal funds rate at year-end.
Source: Vanguard.
Note: All investing is subject to risk, including the possible loss of the money you invest.
Our economic outlook for Canada
Canada finds firmer footing as energy supports growth
“While the United-States-Mexico-Canada Agreement negotiations have brought trade uncertainty back into focus, firmer growth data and rising energy-sector activity suggest the economy is proving more resilient than previously expected.”
-Adam Schickling, Vanguard Senior Economist
The Canadian economy is putting the winter soft patch in the rearview mirror and starting to benefit from the industrial boost associated with higher global oil prices. Real GDP rose 0.6% in April and 0.3% in May, supported by resilient domestic demand, solid income growth, and improving momentum across several manufacturing and trade-sensitive industries.
Higher oil prices are beginning to provide the economic support anticipated, lifting activity across Canada’s mining, quarrying, and energy sectors. At the same time, firms outside the resource sector report that rising energy costs and uncertainty surrounding the North American trade outlook are weighing on investment plans and business sentiment. Even so, the stronger-than-expected recent data have reduced the likelihood of a more pronounced slowdown, and we continue to expect growth to gradually strengthen through the remainder of 2026.
Labour market conditions have also improved, with the unemployment rate matching its two-year low of 6.5%. Labour market weakness remains concentrated among younger workers and recent entrants to the workforce, which is a challenge shared across many developed economies. By contrast, employment conditions for prime-age and higher-income workers have remained relatively stable, with limited evidence of broader labour market deterioration.
While higher energy prices have added some near-term inflation pressure, underlying inflation trends continue to move in a more favourable direction. As a result, we expect the Bank of Canada (BoC) to largely look through the energy-driven increase in inflation. With the economy still operating with modest excess capacity and core inflation continuing to ease, we expect the BoC to remain on hold through the end of 2027.
Canada economic forecasts
| GDP Growth | Unemployment rate | Core inflation | Monetary policy | |
| Year-end 2026 outlook | 1.5% | 6.5% | 2.2% | 2.25% |
| Year-end 2027 outlook | 1.6% | 6.4% | 2.2% | 2.25% |
Notes: GDP growth is defined as the annual change in real (inflation-adjusted) GDP in the forecast year compared with the previous year. Unemployment rate is as of December for each year. Core inflation is the year-over-year change in the Consumer Price Index, excluding volatile food and energy prices, as of December for each year. Monetary policy is the Bank of Canada’s year-end target for the overnight rate.
Source: Vanguard.
Note: All investing is subject to risk, including the possible loss of the money you invest.
Our economic outlook for Mexico
Growth to improve in 2027 despite near-term uncertainty
”Trade uncertainty remains a meaningful headwind for Mexico’s economy, even as growth gradually improves.”
-Thiago Ferreira, Vanguard Senior Economist
We continue to expect the Mexican economic outlook to improve in 2027 on the back of a strong U.S. economy led by AI-related investment and productivity. Renewed tensions between the U.S. and Iran have increased volatility in energy markets, keeping oil prices above levels seen at the time of our previous update and contributing to near-term uncertainty. Still, Mexico’s exposure to the conflict is mainly indirect, operating through higher global energy costs—particularly refined petroleum products and natural gas—rather than through direct supply links to the region.
Demand from the U.S. should help offset Mexico’s recent lackluster domestic performance in the longer term. Despite mixed higher-frequency indicators, second-quarter GDP growth surprised slightly upward at a lukewarm 1.5%, quarter over quarter. Additionally, firms remain cautious as United States-Mexico-Canada Agreement (USMCA) negotiations continue beyond the original July 1 deadline. While current USMCA provisions remain intact, uncertainty surrounding the possibility of annual reviews and the eventual shape of a renewed agreement is likely to weigh on investment and business confidence.
Headline and core inflation improved a bit since last month, and we have accordingly nudged down our forecasts for this year and the next. Still, we still expect disinflation to proceed gradually, as services and core inflation remain sticky and risks from trade disruptions, energy prices, and weather shocks remain tilted to the upside. Contained real wage growth and stable long-run expectations should help inflation further decline over time.
The Bank of Mexico (Banxico) maintained its policy rate at 6.5% in August, signalling that policymakers remain comfortable with the current policy stance. While inflation has moved in a favourable direction, policymakers continue to face a complex backdrop shaped by geopolitical risks, trade uncertainty, and mixed signals from the domestic economy. We expect the policy rate to remain at 6.5% through 2027 as Banxico waits for clearer evidence that disinflation is durable.
Mexico economic forecasts
| GDP Growth | Unemployment rate | Core inflation | Monetary policy | |
| Year-end 2026 outlook | 1.3% | 3% | 3.9% | 6.5% |
| Year-end 2027 outlook | 2% | 3.5% | 3.5% | 6.5% |
Notes: GDP growth is defined as the annual change in real (inflation-adjusted) GDP in the forecast year compared with the previous year. Unemployment rate is as of December for each year. Core inflation is the year-over-year change in the Consumer Price Index, excluding volatile food and energy prices, as of December for each year. Monetary policy is the Bank of Mexico’s year-end target for the overnight interbank rate.
Source: Vanguard.
Note: All investing is subject to risk, including the possible loss of the money you invest.
Our economic outlook for Brazil
Resilient growth allows only gradual easing
“Brazil’s economy remains resilient, but persistent inflation and fiscal uncertainty call for a cautious, gradual easing cycle.”
-Thiago Ferreira, Vanguard Senior Economist
Geopolitical developments and AI are shaping the global backdrop for Brazil, while fiscal policy remains the key domestic risk. Geopolitical effects are more immediate, reflecting recently announced U.S. tariffs on some Brazilian goods and higher energy prices. Over time, Brazil could benefit from AI-related investment through its clean energy base, geopolitical position, and role as a major producer of copper and iron ore. Domestically, elevated public debt and uncertainty ahead of the October 2026 general election remain important risks to the outlook.
Near-term data continue to point to an expanding economy. Consumption growth has accelerated, supported by a tight labour market and fiscal stimulus. Net exports have also contributed positively to recent quarters. We do not expect the recently announced U.S. tariffs to materially affect the outlook because exports to the U.S. represent a small share of Brazil’s GDP and several categories are exempt. Investment, however, has fallen materially from its 2024 highs. We expect growth to moderate over the forecast horizon as the fiscal impulse fades.
Inflation has declined from last year’s peak of 5.5%, but the disinflation process remains incomplete. Headline inflation stands at 4.6%, above the 3% target set by the Central Bank of Brazil (BCB), while services inflation remains elevated. Medium-term inflation expectations have fluctuated within the BCB’s tolerance interval but have not settled at the 3% target, offering limited support for further disinflation. Energy price volatility and a tight labour market should keep inflation persistent, leading to only a gradual return to target.
Monetary policy remains highly restrictive despite the recent start of a cautious easing cycle. The Selic rate remains well above most estimates of neutral and should continue to cool credit and demand over time. Although inflation has recently improved, the persistence of medium-term expectations above the 3% target supports a cautious approach to further rate cuts. We expect only one additional cut this year, followed by further easing once there is greater clarity to the fiscal outlook next year.
Thor Solanes also contributed to this outlook.
Brazil economic forecasts
| GDP Growth | Unemployment rate | Headline inflation | Monetary policy | |
| Year-end 2026 outlook | 2.2% | 5.5% | 5% | 14% |
| Year-end 2027 outlook | 1.9% | 5.9% | 4.3% | 12.25% |
Notes: GDP growth is defined as the annual change in real (inflation-adjusted) GDP in the forecast year compared with the previous year. Unemployment rate is as of December for each year. Inflation is the year-over-year change in the headline broad national consumer price index (IPCA), as of December for each year. Monetary policy is the year-end target for the Selic rate as set by the Central Bank of Brazil.
Source: Vanguard, using the International Monetary Fund’s estimate for Brazil’s gross debt.
Note: All investing is subject to risk, including the possible loss of the money you invest.
Our economic outlook for the United Kingdom
Cooling inflation supports an extended bank rate pause
“As a result of cooling inflation and limited evidence of second-round effects, we no longer expect the Bank of England to raise rates and now look for the bank rate to remain on hold through 2026 and 2027.”
-Shaan Raithatha, Vanguard Senior Economist
A material decline in oil prices, moderating wage growth, and weakness in some services components have led us to revise our inflation forecasts lower. Our new inflation outlook and a dovish July policy meeting have further led us to revise our forecast for the year-end monetary policy rate lower.
Headline inflation eased to 2.6% in June, and while this masked a pickup in energy inflation, oil prices have since receded to just above $80 per barrel. Services inflation moderated from 4.4% to 3.6% from January to June, with core CPI falling from 3.1% to 2.6%. Accordingly, we have downgraded our year-end headline CPI forecast by 50 basis points to 3.1% and our year-end core inflation forecast by 20 basis points to 2.6%. Still, longer-term household inflation expectations remain elevated. This is likely a consequence of inflation not having sustainably returned to 2% since the 2022 Ukraine shock and remains a key risk to the outlook.
We now expect the Bank of England (BoE) to keep the bank rate on hold at 3.75% through 2027. The BoE’s July statement highlighted little evidence of “second-round effects in price and wage-setting” and “clear signs of underlying disinflation,” reinforcing the view that there is no urgency to tighten. Tighter market-implied financial conditions may do some of the work for the bank.
The energy shock remains the key driver of economic activity, and it has evolved broadly in line with our base case. Following a strong first quarter, driven by private and public consumption, we leave our 2026 growth forecast unchanged at 1.1%. We expect activity to soften through the remainder of the year as elevated energy costs and tighter financial conditions weigh on demand. Growth should remain broadly stable around 1.2% in 2027 as the drag from the energy shock fades.
On fiscal policy, the appointments of a new prime minister and chancellor have increased uncertainty, though the government’s commitment to fiscal credibility suggests any changes are likely to be gradual, implying only modest shifts in the U.K.’s fiscal trajectory.
United Kingdom economic forecasts
| GDP Growth | Unemployment rate | Core inflation | Monetary policy | |
| Year-end 2026 outlook | 1.1% | 5.3% | 2.6% | 3.75% |
| Year-end 2027 outlook | 1.2% | 5.3% | 2.5% | 3.75% |
Notes: GDP growth is defined as the annual change in real (inflation-adjusted) GDP in the forecast year compared with the previous year. Unemployment rate is as of December for each year. Core inflation is the year-over-year change in the Consumer Prices Index, excluding volatile food, energy, alcohol, and tobacco prices, based on the fourth-quarter average for each year. Monetary policy is the Bank of England’s bank rate at year-end.
Source: Vanguard.
Note: All investing is subject to risk, including the possible loss of the money you invest.
Our economic outlook for the euro area
Activity proves resilient amid the energy shock
“Euro area activity has so far proven resilient to the energy shock, and we leave our 0.8% growth forecast for 2026 unchanged. We expect the European Central Bank to lean against inflation risks with one further hike this year before policy gradually eases as the shock fades.”
-Shaan Raithatha, Vanguard Senior Economist
Our euro area outlook is clouded by the reescalation of geopolitical tensions. Even so, activity has proven resilient: Second-quarter GDP accelerated to 0.4% quarter over quarter, and all four major economies expanded. Moreover, high-frequency data have firmed, with July’s composite Purchasing Managers’ Index rising back above the no-change mark, manufacturing output at its highest level since early 2022, and economic sentiment improving.
The energy shock has evolved broadly in line with our base-case scenario, leaving our 2026 GDP growth forecast unchanged at 0.8%. We expect growth to rise to 1.3% in 2027 as headwinds from the energy shock and last year’s trade shock fade. German fiscal stimulus remains a tailwind through military and infrastructure spending.
Inflation has evolved broadly in line with our base case. We expect headline inflation to end 2026 at 3.3%, as the pass-through of high energy costs continues to feed through to prices. Risks skew to the downside, should energy prices continue to ease. We foresee core inflation moderating to 2.2%.
We continue to view the risk of inflation expectations becoming de-anchored as low, reflecting a credible European Central Bank (ECB), moderating wage growth, and a less tight labour market than during the pandemic-era inflation surge of 2022. Overall, we see limited evidence that the energy shock will generate material or persistent second-round inflation effects.
Against this backdrop, we expect the ECB to follow up its June hike with one further increase later this year, likely in September. We view both as insurance hikes: With the conditions for entrenched inflation absent, the need for restrictive policy should diminish once energy prices stabilise, and we look for policy to reverse with two cuts in 2027.
Euro area economic forecasts
| GDP Growth | Unemployment rate | Core inflation | Monetary policy | |
| Year-end 2026 outlook | 0.8% | 6.4% | 2.2% | 2.5% |
| Year-end 2027 outlook | 1.3% | 6.3% | 2.3% | 2% |
Notes: GDP growth is defined as the annual change in real (inflation-adjusted) GDP in the forecast year compared with the previous year. Unemployment rate is as of December for each year. Core inflation is the year-over-year change in the Harmonized Indexes of Consumer Prices, excluding volatile energy, food, alcohol, and tobacco prices, based on the fourth-quarter average for each year. Monetary policy is the European Central Bank’s deposit facility rate at year-end.
Source: Vanguard.
Note: All investing is subject to risk, including the possible loss of the money you invest.
Our economic outlook for China
Slower growth raises urgency for policy support
“The growth through in the second quarter will likely keep policymakers alert, accelerating the implementation of existing policy measures.”
-Grant Feng, Vanguard Senior Economist
China’s economic growth slowed to 4.3% year over year in the second quarter, falling short of market expectations. Weak domestic demand and moderating fiscal support outweighed continued strength in industrial production, particularly in technology-related sectors benefiting from resilient exports. June activity data further underscored the widening divergence between supply and demand.
One encouraging development was the return of the GDP deflator—a broad measure of inflation—to positive territory for the first time in three years, partly reflecting higher energy prices associated with the Middle East conflict. Renewed tensions in the region have increased the risk that oil prices could remain elevated for longer.
Still, an energy shock alone is unlikely to end China’s deflationary pressures or put the economy on a Japan-like reflationary path, given China’s lower energy exposure, more resilient currency, limited corporate pricing power, and continued labour market slack.
Looking ahead, export demand is likely to remain relatively firm in the near term, supported by the global AI investment cycle. However, exports alone cannot generate a durable and broad-based recovery. That will require quicker fiscal execution and stronger demand-side policy support. Without such measures, domestic demand is likely to remain subdued, and the economy’s increasingly K-shaped recovery will persist.
On policy, we expect support to remain targeted, incremental, and focused on implementation. The Politburo meeting in July reinforced our view that policymakers will prioritise accelerating existing fiscal measures, improving the transmission of previously announced policies, and making fuller use of available policy space, rather than launching a large-scale, broad-based stimulus package.
China economic forecasts
| GDP Growth | Unemployment rate | Core inflation | Monetary policy | |
| Year-end 2026 outlook | 4.7% | 5.1% | 1.2% | 1.4% |
| Year-end 2027 outlook | 4.8% | 5% | 1.3% | 1.4% |
Notes: GDP growth is defined as the annual change in real (inflation-adjusted) GDP in the forecast year compared with the previous year. Unemployment rate is as of December for each year. Core inflation is the year-over-year change in the Consumer Price Index, excluding volatile food and energy prices, as of December for each year. Monetary policy is the People’s Bank of China’s seven-day reverse repo rate at year-end.
Source: Vanguard.
Note: All investing is subject to risk, including the possible loss of the money you invest.
Our economic outlook for Japan
A hawkish pause as case for normalisation strengthens
“The Bank of Japan is becoming more confident that the economy can withstand further policy normalisation, with upside inflation risks supporting continued rate hikes.”
-Grant Feng, Vanguard Senior Economist
The Japanese economy continues to expand moderately, broadly in line with the outlook of the Bank of Japan (BoJ). The June Tankan survey showed that business sentiment remains favourable, with firms maintaining a positive investment stance despite lingering uncertainty in the Middle East. Strong outcomes from the annual union wage negotiations—known as Shunto—also point to sustained underlying momentum, which should help cushion the economy against a sharper slowdown should energy prices rise further.
Fiscal support, including energy subsidies and a consumption tax cut, should partially offset the drag from higher energy costs. At the same time, the global AI investment cycle is providing an additional tailwind to external demand and business investment, supporting Japan’s medium-term growth outlook.
Although near-term inflation momentum has softened somewhat, we expect higher upstream costs to pass through gradually to consumer prices. Renewed cost pressures, combined with upside risks from exchange-rate pass-through and further services-sector price adjustments, should reinforce the BoJ’s assessment that monetary conditions remain highly accommodative and that there is scope for additional normalisation.
Firms also appear increasingly willing to pass higher costs on to consumers. This suggests that increases in import and producer prices are likely to feed through more visibly to consumer prices, contributing to a renewed rise in inflation from this summer onward.
At its July meeting, the BoJ left its policy rate unchanged and adopted more hawkish guidance. The central bank slightly raised its growth forecasts for fiscal years 2026 and 2027, partly reflecting positive spillovers from stronger global AI-related demand, and judged that inflation risks are skewed to the upside. This reflects the potential for a further shift in corporate wage- and price-setting behaviour, alongside continued increases in medium- to long-term inflation expectations.
We continue to expect an additional rate hike by the end of 2026, taking the policy rate to 1.25%. The timing will depend on incoming inflation, wage, and activity data, as well as the extent of yen weakness and its implications for import prices and inflation expectations.
Japan economic forecasts
| GDP Growth | Unemployment rate | Core inflation | Monetary policy | |
| Year-end 2026 outlook | 0.8% | 2.4% | 2.1% | 1.25% |
| Year-end 2027 outlook | 1.2% | 2.4% | 2.2% | 1.75% |
Notes: GDP growth is defined as the annual change in real (inflation-adjusted) GDP in the forecast year compared with the previous year. Unemployment rate is as of December for each year. Core inflation is the year-over-year change in the Consumer Price Index, excluding volatile fresh food prices, as of December for each year. Monetary policy is the Bank of Japan’s year-end target for the overnight rate.
Source: Vanguard.
Note: All investing is subject to risk, including the possible loss of the money you invest.
About the Vanguard Capital Markets Model
The asset-return distributions shown here are in nominal terms—meaning they do not account for inflation, taxes, or investment expenses—and represent Vanguard’s views of likely total returns, in U.S. dollar terms, over the next 10 years; such forecasts are not intended to be extrapolated into short-term outlooks. Vanguard’s forecasts are generated by the VCMM and reflect the collective perspective of our Investment Strategy Group. Expected returns and median volatility or risk levels—and the uncertainty surrounding them—are among a number of qualitative and quantitative inputs used in Vanguard’s investment methodology and portfolio construction process. Volatility is represented by the standard deviation of returns.
IMPORTANT: The projections and other information generated by the Vanguard Capital Markets Model (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. 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 importantly, 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 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, U.S. municipal bonds, 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 time. Forecasts represent the distribution of geometric returns over different time horizons. Results produced by the tool will vary with each use and over time.
The VCMM’s primary value is its utility in analysing potential investor portfolios. VCMM asset-class forecasts—comprising distributions of expected returns, volatilities, and correlations—are key to the evaluation of potential downside risks, 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 is the most effective way to use VCMM output. The VCMM seeks to represent the uncertainty inherent in forecasting by generating a wide range of potential outcomes. The VCMM does not impose “normality” on expected return distributions but rather is influenced by the so-called fat tails and skewness of modelled asset-class returns. Within the range of outcomes, individual experiences can be quite different, underscoring the varied nature of potential investment outcomes. Indeed, this is a key reason why we approach asset-return outlooks in a distributional framework.
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Note: The examples contained in this article are illustrative only and are based on the factors stated. It should not be taken to contain or provide an estimate or forecast of actual outcomes.
Past performance information is given for illustrative purposes only and should not be relied upon as, and is not, an indication of future performance.
Actual outcomes may differ materially from those referred to in these statements. An investment is subject to investment risk, including possible delays in repayment and loss of income and principal invested. Distributions and capital growth are not guaranteed.