Vanguard has issued a new report highlighting that while economic growth and investment are on the rise, expectations for U.S. equities may need to be tempered due to high valuations. The report suggests that the anticipated benefits of artificial intelligence (AI) on economic growth may not fully translate into robust stock market returns.
In its annual forecast, Vanguard offers a nuanced view of an AI-driven expansion that promises to enhance productivity and capital investment over the coming years. However, the firm warns that the rapid enthusiasm surrounding AI has outpaced many companies’ abilities to convert that excitement into tangible shareholder value.
The analysis, conducted by Vanguard’s global economics, markets, and portfolio construction teams, projects that U.S. economic growth will reach approximately 2.25% by 2026, driven in part by increased capital spending related to AI infrastructure. Core inflation is expected to cool to around 2.6% by the end of 2026, with unemployment levels anticipated to remain near 4.2%.
In contrast, Europe is expected to see inflation fall below the European Central Bank’s 2% target, which could lead to a more accommodative policy environment.
Despite the favorable economic forecast, expectations for U.S. equities are less optimistic. Vanguard cautions that current stock prices reflect elevated expectations for earnings growth and profitability, leaving valuations susceptible to declines if AI investments do not yield returns swiftly.
The report underscores that large-scale AI investments tend to generate positive net present value mainly for companies with strong competitive advantages and access to low-cost capital. In contrast, firms that lack these advantages may face challenges in realizing returns.
Vanguard outlines three potential scenarios for U.S. equity returns over the next decade. In the most optimistic scenario, where AI adoption exceeds expectations, annualized returns could reach between 8% and 10%. However, Vanguard assigns a relatively low probability to this outcome. The firm’s base case predicts that AI will evolve into a general-purpose technology, resulting in more moderate returns of 5% to 7%. A downside scenario, marked by waning enthusiasm and contracting valuations, could leave investors with returns ranging from slightly positive to negative in real terms.
In contrast to equities, Vanguard offers a more favorable outlook for bonds. The firm argues that higher estimates of neutral interest rates point to more promising long-term prospects for fixed-income investments compared to what investors have experienced since the financial crisis. Consequently, Vanguard advocates for diversified portfolios with significant bond allocations, balancing equity risk judiciously.
Additionally, Vanguard challenges the notion that AI will lead to widespread job losses. The firm’s research indicates that occupations highly exposed to AI have continued to experience job and wage growth comparable to other sectors, suggesting that near-term labor disruptions may be less severe than some have feared.
As the landscape evolves, the interplay between AI advancements and economic growth will remain crucial for investors. While the short-term outlook for U.S. equities appears cautious, the potential long-term benefits of AI integration present an area of significant interest for market participants.
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