According to CIO Vanguard, there are two reasons why the stock market will underperform over the next few years

• U.S. stocks will underperform, according to Vanguard’s chief investment officer.
• The company estimated that the S&P 500 index would gain between 4.7% and 6.7% over the next few years.
• That’s well below the recent average, thanks to two dynamics that are dampening the stock’s outlook.

According to Vanguard Chief Investment Officer Greg Davis, U.S. stocks could see disappointing performance over the next few years.

In an interview with CNBC on Friday, he estimated that stocks will deliver below-average returns to investors in 2024 and beyond, averaging 4.7% to 6.7%. This is well below the previous returns of the S&P 500, which ranged around 9-10%.

Davis said there are two reasons why U.S. stocks are so primed for such poor returns:

1. Valuations are too high.

Most of the recent gains seen in U.S. stock markets are largely due to expansions in valuations, but valuations cannot continue to rise indefinitely, Davis said, especially given that markets are emerging from the Great Moderation, a period when interest rates were very low and financial conditions were loose and the stock provided consistent returns.

Davis said U.S. stocks have outperformed international stocks by about 8 percentage points over the past decade, and that trend is unlikely to continue. Over the last year and a half, the Fed has aggressively raised interest rates to tamp down inflation, which has already pushed stock prices lower in 2022.

Vanguard predicted that U.S. stocks would return around 5% annually over the next few years, while international stocks would return around 7% to 9%.

2. The risk premium in the stock market is too low.

The equity risk premium on the U.S. stock market, the excess return on equity investments above the risk-free rate, is about 2 percentage points below the long-term average, Davis. This means that US bonds are becoming a more attractive investment option, with the yield on 10-year treasury bonds hovering around 5% over the past month.

The opposite situation occurs in international markets, where the equity risk premium actually makes stocks more attractive than bonds.

“How much do they pay you to invest in stocks versus 10-year treasuries? In the U.S. market, it’s not as compelling,” Davis said.

Investors appear to have taken notice, with weekly flows in U.S. stocks turning slightly negative over the past three weeks, according to data from Bank of America.

Meanwhile, some forecasters warned investors about the prospects for the stock market. Some market veterans say there are signs of economic weakness beneath the surface. This could potentially signal an upcoming recession.