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By Christine Benz | 10-03-2013

Vanguard's Davis: Equity valuations not alarming yet

Stock prices have begun to outpace earnings growth, but investors should still see high-single-digit returns from stocks during the next decade, says Vanguard chief economist Joe Davis.

Christine Benz: Hi, I'm Christine Benz for Morningstar. I am here at Morningstar's ETF Invest Conference, and I am joined by Joe Davis. He is chief economist at Vanguard.

Joe, thank you so much for being here.

Joe Davis: Thank you, Christine. Great to see you again.

Benz: Great to see you, too. You gave a terrific speech where you gave your outlook for growth in the economy as well as inflation. I'd like to start there: What is your forecast for economic growth?

Davis: I think in the near term, it's still one of caution. I mean, Christine, we've been one of having a longer-term cautiously optimistic view given some of the progress we've seen in the private sector. But if investors are looking out over the next six to 12 months, we're not seeing the sort of indications that we're going to see an acceleration outside of this 2% or so real GDP growth, a trend that we've been in.

We've seen improvement in investment, in some of the consumer-spending measures, and in the financial markets clearly. But it's the pall I think that overhangs sentiment which is still at a very low level given, I think, policy uncertainty quite frankly that is holding that back.

So I think a reasonable expectation is actually a little bit lower than where the Federal Reserve may be hoping at this present time. But if we could see greater clarity over the next month in terms of some of these initiatives, then I think that the Federal Reserve's outlook of a modest acceleration I think is actually appropriate. We're the closest we have been in six years to kind of getting out of this 2% to closer to 3% growth, but we're not there yet.

Benz: Obviously a big headwind or certainly a pall hanging over everything right now is the shutdown in Washington currently. How does that affect or not affect your outlook for growth?

Davis: It's a significant effect. In fact, we did a analysis and Bill McNabb, Vanguard's chairman, used a phrase at the beginning of the year, this "uncertainty tax," this concept that even the rise of policy uncertainty over and above normal conditions can act as a drag on business investment and, hence, economic activity. We saw this in the middle of 2011; we saw that in 2010 with Europe. We saw it last year, and I would anticipate that we will see it through the month of October. I would hope not, but I think it's likely that we will. So, I think there is the risk that the economic statistics disappoint for a little bit, before ultimately, what I would hope, we see the debt ceiling averted and we see a resolution take place.

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