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At long last, a forecast worth heeding

(MoneyWatch) It's been my observation that so many of the market forecasts made by financial pundits are nothing more than fauxcasts that cause investors to make foolish bets. That said, I recently came across a forecast presented by Vanguard's institutional group that I thought had real value, and Vanguard gave me permission to use it. Below is the forecast followed by my commentary.

Vanguard market outlook

Stock outlook

- Positive expected long-run equity risk premiums
- Volatility may remain elevated, given macro currents
- Fallacy of "new normal": Low GDP growth = low stock returns
- Near-term forecasts are pointless
- Global diversification critical in years ahead

Bond outlook

- Low-yield environment may continue to depress long-term U.S. interest rates
- Medium-term bond returns very muted relative to history; risk of loss elevated
- Short-duration strategies can be risky, given steep curve and near-0% short rates
- Strategic role of bonds in balanced portfolio remains strong
- Low yields make razor-thin costs for bond portfolios more important than ever

On Vanguard's stock forecast

Vanguard's outlook does not display the foolishness of Northern Trust's chief investment strategist, who recommends buying stocks on margin at the all-time high. Vanguard's prediction is based on the belief that, in the long run, capitalism works and investors should expect to earn more in stocks than lower-risk bonds. Near-term forecasts of stocks are, in my opinion, worse than pointless and likely to lead us down the buy high, sell low rabbit hole.

I am in complete agreement with the most of Vanguard's analysis. We live in a global economy and we should invest globally. The new normal is likely to diminish your returns. Data does show that lower GDP growth is slightly correlated with higher market returns. The recent underperformance of emerging-markets stocks is not an anomaly.

My only disagreement with Vanguard's stock outlook is that volatility may remain elevated. My own research shows that high market volatility is a myth and that it has been no higher than historic levels over the past three years.

On Vanguard's bond forecast

The medium-term risk to bonds is likely to be higher than normal because if rates rise, bonds decline in value. While we don't know exactly when that will happen, we know rates can't go much lower.

While this scenario is scary, I agree with Vanguard's statement that short-term bonds yielding close to zero guarantee a loss of purchasing power. I also agree that one should never forget the role of high-quality bonds as the shock absorber for a portfolio when stocks plunge. The short memories of investors leads them to forget the value of this when the pain of a plunge -- like that of March 9, 2009 -- passes and the Dow edges up. Finally, because rates are so low, investors seem to be giving up most, if not all, of their yields in fees.

I prefer a non-Vanguard solution to the bond risks mentioned above. I like CDs with small early withdrawal penalties. For example, the Ally Bank 5-year CD is yielding about 1.54 percent APY, which is about the same as the Vanguard Total Bond Market Index Fund (VBMFX). If rates rise by 1 percent, that fund would decline by about 5.3 percent. The 60-day early withdrawal penalty amounts to only 0.26 percent. I'm not foolish enough to predict such a rate increase, it's certainly a possibility, and one can think of the 0.26 percent penalty as the deductible on a free insurance policy.

My take

I can't remember ever seeing such a useful market forecast as this. It's full of uncommon common sense that is just as useful to you as to the institutions this forecast was presented to.