Oliver Strewe—Getty Images/Lonely Planet Image
By Paul J. Lim
April 12, 2016

In what’s being viewed as another blow to the economy, the International Monetary Fund lowered its forecasts for global growth for 2016 from 3.4% to 3.2%.

In announcing the move, the IMF noted that “the global recovery has weakened further amid increasing financial turbulence.”

The IMF’s decision comes on the heels of a similar move by the Federal Reserve, which recently trimmed its expectations for U.S. economic growth in 2016 from 2.4% down to 2.2%.

For investors worried about the health of the economy, this surely feels like another punch in the gut, especially because from 1980 to the global financial crisis, the U.S. economy had been growing at an annual rate of 3.1%.

Could this be a sign that we’re headed for ’70s-style stagnation?

Not necessarily.

Sure the economic recovery has been sluggish and disappointing. But Joe Davis, global chief economist at Vanguard, points out that before the global financial crisis, “the growth rates of 3%-plus reflected a combination of organic strength and ‘performance-enhancing’ supplements.”

In other words, the economy had been juiced with steroids in the years leading up to the financial crisis—in the form of debt-financed growth.

Davis notes that by early 2008, home mortgage debt had grown to equal 77% of gross domestic product, up from a mere 33% in 1980. And this “borrowing underwrote steady growth in consumer spending, which rose from 62% of economic activity in 1980 to 68% in 2007,” Davis argued. “At that point, of course, debt service began to overwhelm household incomes, and bad loans burned holes through bank balance sheets, igniting the global financial crisis.”

These recent cuts in economic forecasts have been modest, and they could serve a useful purpose by resetting investor expectations about growth in the post economic-steroid era.

Slower growth forecasts may not be evidence of stagnation, but “a reasonable expectation for a developed economy with a slowly growing labor force,” said Davis, who also serves as head of Vanguard’s investment strategy group.

Similarly, Davis thinks it’s time for investors to reset their expectations for market returns.

“Our simulations indicate that over the next decade, the average annualized returns of a 60% stocks/40% bonds portfolio will most likely be in the 3% to 5% range after inflation,” he said.

To be sure, “this is below the average after-inflation return of 5.5% for the same portfolio from 1926 through 2015,” he said.

But that’s the reality in the post-steroid era.

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