Joe Davis, Vanguard - The Idea Multiplier…We Believe It’s One Of The First Leading Indicators Of Commercial Innovation | #202

Episode Summary

Executive Summary: Joe Davis of Vanguard explains why the firm expects subdued long-term returns, how its capital markets model incorporates valuations and macro factors, and why international stocks and high-quality fixed income may look better than many assume. He also discusses negative rates, investor expectations, and two research projects: the idea multiplier, which suggests innovation and growth may reaccelerate, and the future of work, which argues most jobs will change rather than disappear.

Main Topics: Vanguard’s long-term return outlook (Priority: 5/5): Davis explains that Vanguard focuses on 5- to 10-year distributions rather than point forecasts and sees muted expected returns because U.S. valuations are rich and risk premiums are compressed. How the Vanguard Capital Markets Model works (Priority: 5/5): He describes the model as a global, endogenous system that evolves inflation, growth, valuations, and term structure through time to generate probability distributions rather than single-number forecasts. CAPE, valuations, and real rates (Priority: 5/5): Davis argues CAPE is useful but must be adjusted for macro conditions like real rates and inflation volatility; fair value P/Es can rise in low-rate environments. International equities and the U.S. dollar (Priority: 4/5): He says non-U.S. stocks appear more attractive than U.S. large caps over a 10-year horizon, driven by valuation gaps and expected dollar weakness. Negative interest rates and fixed income (Priority: 4/5): Davis says negative rates are a policy mistake in principle, but explains them through secular forces, collateral scarcity, and fixed income’s diversification value. The Idea Multiplier and future growth (Priority: 5/5): A new research project using billions of publication and citation records suggests ideas are multiplying faster, potentially signaling a future pickup in commercial innovation and growth. Future of work and automation (Priority: 4/5): His research suggests technology will transform many jobs by changing task mix rather than eliminating them outright, with only a smaller share facing major displacement.

Key Arguments: Vanguard’s outlook is intentionally probabilistic: the firm tries to estimate the full distribution of outcomes over 5-10 years, not next year’s market direction. Subdued expected returns are not a bearish call on the economy; they mainly reflect high valuations and low real rates, especially in the U.S. CAPE remains useful, but its fair-value benchmark should shift with interest rates and inflation conditions rather than being compared to a fixed historical average. International equities should, on average, outperform U.S. large caps over the next decade because of cheaper valuations and possible U.S. dollar depreciation. Negative nominal rates are hard to justify as stimulus because they may lower inflation expectations; they also face institutional and market-structure constraints in the U.S. The idea multiplier suggests innovation is not dead; rather, knowledge compounding may be accelerating in fields like genetics, energy, and materials. Most jobs are task bundles, so automation is more likely to reshape work than fully erase it; workers and firms must adapt to changing skill demands. Long expansions can last far longer than investors assume, and history shows recessions are not caused by old age alone.

Data Points: Vanguard 2020 U.S. equity expected return: 3.5% to 5.5% nominal - Long-term outlook range discussed for U.S. equities Vanguard 2020 global equities expected return: roughly 9% in the 2009-2010 outlook - Referenced as the firm’s earlier post-crisis forecast, which proved accurate over time International equity advantage: 300-400 basis points higher than U.S. equities on average - 10-year expected return differential in Vanguard’s outlook Research database size for idea multiplier: 2 billion records - Published research and citation records used to map idea diffusion Idea multiplier ratio: 200 ideas for every influential one - Described as stagnant for about 15 years before recent improvement Idea multiplier in genetics: roughly 200 to 400 to 1, and in some cases over 3,000 - Shown as especially strong in genetics/genome research Future of work estimate: roughly 20% of occupations with significant downward pressure - Jobs most exposed to direct tech substitution Work task change: 50% - Average job task profile change over the past decade Duration without recession in early U.S. history: 17 years - Pre-Civil War expansion cited as longer than the current one Current expansion length at time of interview: 11th year - Used to compare with historical long expansions Globalization/factors behind low rates: 3 secular forces - Technology, globalization, and demographics are cited as drivers of low growth and low real rates Fair value estimate for 10-year Treasury: unchanged for 4-5 years - Despite growth in debt, structural forces kept the estimate stable Potential policy move in recession: possible 2-year Treasury negative - Davis thinks short-rate policy in the U.S. is less likely to go negative than intermediate rates Return expectations for many pensions: 6.5%-9% - Average pension assumptions contrasted with Vanguard’s lower expected returns

Pivotal Quotes: "we refuse to do it, but that's because I think we're just honoring the predictability that the modest predictability. Think that we have." — Joe Davis: Why Vanguard avoids point forecasts and instead publishes return distributions "I think the best thing that could happen to the world would be a 200 basis point rise in real yields across the board." — Joe Davis: On the consequences of higher real rates for savers, pensions, and long-term returns "we believe we found the first upside risk to global growth" — Joe Davis: His reaction to the idea multiplier research suggesting innovation may reaccelerate

Implications: Investors should recalibrate return expectations, diversify globally, and focus on probabilities rather than forecasts. Vanguard’s research suggests low rates and subdued returns may persist, but innovation and growth could surprise to the upside over time.