Vanguard Says Non-U.S. Equities Have More Attraction Than U.S. Equities

The illustration makes the extent of the overvaluation clear. The solid blue line representing U.S. equities' cyclically adjusted price/earnings ratio leaps from its fair-value range, represented by the gray band, just as it did for an extended period before the dot-com bubble burst.

One of the key take aways from their economic and market outlook shouldn't be a surprise. They've said for a few years that U.S. equity valuations were approaching "stretched" territory. A strong 2021 run-up in prices driven more by valuation expansion than by increased profits makes U.S. equities more overvalued than at any other time since the dot-com bubble.

Vanguard's assessment is based on the latest quarterly running of the Vanguard Capital Markets Model (VCMM), as of September 30, 2021. The model considers equity valuations relative to their fair value, conditional on interest rates and inflation. Rising interest rates erode the present value of future cash flows, so interest rates and inflation tend to influence equity market valuations—and, by extension, prices.

Specifically, they are projecting the lowest 10-year annualized return projections for global equities since the early 2000s. We expect the lowest ones in the U.S. (2.3%–4.3% per year), with more attractive expected returns for non-U.S. developed markets (5.3%–7.3%) and, to a lesser degree, emerging markets (4.2%–6.2%). The outlook for the global equity risk premium is still positive but lower than last year's, with total returns expected in the range of 2 to 4 percentage points over bond returns.

Recent outperformance has only strengthened our conviction innon-U.S. equities, which have more attractive valuations than U.S. equities. Although emerging-market equities are above our estimate of fair value, we still expect higher returns than the U.S. and diversification benefits for investors.

Within U.S. markets,theythink value stocks are still more attractive than growth stocks, despite value's outperformance over the last 12 months.