CaptionImage by Arek Socha from Pixabay 

In its annual report on the economy and financial markets, Vanguard Group anticipates muted growth for U.S. stocks over the next 10 years – projecting 4% to 5% average annualized returns.

That would be a far cry from the roughly 12% return that U.S. stocks, as gauged by the Vanguard Total Stock Market Index Fund ETF (NYSEARCA: VTI), have returned annually over the past 10 years.

The report, titled “AI exuberance: Economic upside, stock market downside,” finds that the U.S, markets will not be driven by AI and technology stocks over the long term. Instead, it posits that high-quality bonds, value stocks, and international equities will be the best places to invest.

Despite the glamor of the tech-heavy U.S. equity market, more compelling investment opportunities are emerging in high-quality fixed income, U.S. value, and ex-U.S. equity—even for those investors most bullish on AI’s prospects,” Joe Davis, global chief economist and global head of Investment Strategy Group at Vanguard, said. “Long-term investors will continue to benefit from a portfolio consisting of fixed income and globally diversified equities.”

2026 probably won’t look much different

In the near-term, however, AI-driven tech and growth stocks will continue to drive markets.

“For U.S. equities in 2026, we expect a continuation of the recent past, where returns are solid, driven by rising earnings growth,” the report states. “And the risk may skew to the upside. Consider the odds of stronger-than-expected AI capital investment, faster AI diffusion across a broad swath of sectors, and a strong wealth effect (owing to a multiyear boom in the stock market and rising home prices) fueling U.S. consumption.”

The momentum should continue, even at the current stretched valuations, particularly if AI scalers continue to grow earnings.

As of November, the cyclically adjusted price/earnings (CAPE) ratio was about 37, which is in the top 10% of valuation since 1988. However, the report notes that the Nifty 50 in the 1970s and the dot-com boom in 1998 were similar to today with strong corporate earnings growth and rapid valuation multiple expansion.

However, our conviction is growing stronger that long-term prospects for U.S. equities are subdued — around 4% to 5% annualized returns over the next 10 years,” the report said. “Our muted long-term return projection for U.S. equities is entirely consistent with our more bullish prospects for an AI-led U.S. economic boom.

Why Vanguard sees muted long-term returns

Vanguard outline two major reasons why it expects U.S. stock returns to be in the mid-single digits over the next 10 years.

One, it says the market may be underpricing the potential for AI capital investment to underdeliver.

“Such adverse capital investment behavior is often associated with lower profits until winners emerge. And the danger for any of today’s AI scalers is that they emerge from this vast buildout phase overextended, triggering a less optimistic profit trajectory,” the outlook said.

Vanguard’s analysis suggests that the net present value (NPV) of AI investments is uncertain and could be negative. Further, the necessity for continued massive capital expenditures in resources like chips and data centers could erode profit margins and make it more challenging for AI scalers to deliver the expected earnings growth.

Two, AI scalers face a rapidly evolving technological landscape, which brings the threat of creative disruption.

“History suggests that the companies earning excess profits at the frontier of new technologies are unlikely to all do so in the future. Indeed, some of the winners of the next decade may be small, unknown companies in today’s market that can build new businesses on the infrastructure laid by today’s AI scalers,” Vanguard strategists wrote.

In other words, the ability of the current leaders to transform investment into lasting advantages is not assured, increasing the uncertainty around future returns.

Finding value

U.S. value stocks and international stocks have a better long-term return profile, according to Vanguard. The investment manager sees annual returns of 7% and 6%, respectively, for these asset classes over the next 10 years.

“Both segments offer much more attractive valuations and have yet to fully price in the potential long-term benefits of AI adoption. As AI diffuses across all sectors of the economy, value-oriented sectors such as industrials, financials, and select consumer segments may be better positioned to realize efficiency gains and grow earnings, making them potentially more attractive in the medium term,” Vanguard experts state in the report.

They can serve as a hedge should there be a bear market or extended drawdown.

More By This Author:

Here’s Why ANF Is Rallying
Nvidia Gets Trump Approval To Sell In China, So Why Is Stock Down?
Early December ETFs See $153M Exit as Bitcoin And Ethereum Pull Back After Late-November Gains