If you don’t like the neighborhood, wait 10 minutes.
That’s an old saying about New York City, but it applies to the bewildering financial markets, too. You may not like what you’re experiencing, but everything is changing so rapidly that it’s smart to avoid quick judgments.
When major government policies shift overnight, making long-term economic projections is quixotic, at best. Still, some people do it for a living.
I spoke with one of the most thoughtful, Joseph H. Davis, global chief economist of Vanguard, the giant asset-management company. He has written a new book, “Coming Into View: How AI and Other Megatrends Will Shape Your Investments.”
It takes a decades-long perspective. At its core is Vanguard’s proprietary model, estimating a range of potential outcomes in what Davis calls a tug-of-war between artificial intelligence and an aging society.
In a nutshell, Vanguard projects two main possibilities:
• Technological breakthroughs, including but not limited to AI, create a thorough revolution in productivity, transforming “how we do our jobs, driving faster growth and improved standards of living.” The company estimates a 45% to 50% chance that this will happen.
• AI will be disappointing and won’t outweigh negative trends like rising fiscal deficits and an aging population, leading to inflation and economic stagnation. Vanguard assigns this outcome a 35% to 45% probability.
Classic diversification, plus a tilt toward beaten-down value stocks, can protect you, even if AI is spectacularly successful, Davis said. “You don’t have to pick sides; you don’t have to be a hero,” he said.
For investors who use broad index funds and hold only U.S. securities, the Vanguard model projects two disparate sets of annualized returns from 2026 through 2035:
• In the “deficits dominate” world, bonds outperform equities during a miserable decade for the stock market. Ten-year Treasuries return 6.5% annualized versus 2.3% for the S&P 500.
• In the optimistic, “AI transforms” version, stocks rule. The S&P 500 returns 9.8% annualized versus 3.9% for 10-year Treasuries.
I take all economic and market forecasts with many grains of salt, but I respect this effort.
Two Paths, One Destination
Perhaps the study’s most fascinating recommendation is its advocacy of value stocks.
First, some definitions are in order: Value stocks are priced well below what their advocates consider to be their real worth. They may be bargains. They may be cheap for good reason and never flourish.
That contrasts with growth stocks, which promise a lot of future earnings but often deliver less than other stocks right now. By and large, tech stocks tend to be growth stocks; value stocks usually include banks, utilities, consumer-goods outfits, fossil-fuel energy companies and some health care firms.
For decades, growth has outperformed value in the stock market, so advising people to hold more value stocks is a contrarian call. In the 20 years through to this month, for example, the S&P 500 Value index returned 8.5% annualized, compared with 12.5% for the S&P 500 Growth index and 10.8% for the overall S&P 500, according to FactSet.
Davis says value stocks are a good idea, whatever happens. Under the more upbeat of his two alternatives, AI turns out to be everything its promoters claim, and its benefits filter throughout the economy. Productivity soars.
The advent of practical, widely available electricity at the turn of the 20th century may be an analogy, Davis says. Electricity made manufacturing immensely safer as factories “transitioned away from the steam-powered drives and pulleys that were often the cause of workplace fatalities,” Davis wrote. And it spawned new industries, like mass-produced automobiles.
“The time spent by a worker on manufacturing a car went down, while the value of the car went up,” Davis wrote. Something like this might possibly happen if AI is entirely successful, bolstering incomes, transforming lives and creating a new economy
I’m agnostic about AI. I don’t believe it belongs in a league like this, but I’m not sure.
No matter. Let’s assume for now that we are truly at the start of an awesome new era. In such a case, which stocks would benefit most? The obvious answer, one that is bolstering the market right now, is the high-flying tech stocks — companies like Alphabet, Amazon, Apple, Meta, Microsoft, Nvidia, Oracle and Broadcom, which are already highly valued, at least partly because of assumptions about AI.
But precisely because their steep valuations already reflect widespread expectations of AI success, these companies may not be the best bets, even if they are performing fabulously in the market now. Instead, if AI makes virtually all companies more productive, the biggest gains may come elsewhere, in stocks that few people consider avatars of artificial intelligence.
What kinds of stocks? Vanguard’s S&P 500 Value ETF includes Exxon Mobil, Chevron, Procter & Gamble, Berkshire Hathaway, Johnson & Johnson and J.P. Morgan. Many smaller value stocks not on my radar right now might prosper in this beneficent AI world.
A Darker Turn
On the other hand, let’s say that AI turns out to be a big, money-wasting mania — one of the “extraordinary popular delusions” that Charles Mackay wrote about in 1841 and that have periodically crashed the world’s stock markets. Say that AI is a cluster of technologies providing immense entertainment and real advances in some sectors — accompanied, unfortunately, by job losses in vulnerable occupations — but it never supercharges productivity throughout the economy.
In these darker versions of the future, AI isn’t powerful enough to counteract deep economic problems. Such issues as rising debt levels, slowing growth, an aging population — as well as mounting impediments to global trade — translate to higher interest rates and lower stock market returns. There could well be “a lost decade” in the markets, Davis writes.
In this gloomier world, higher stock valuations come down, growth stocks suffer, and cheap but profitable value stocks prosper, Davis said.
“If you’re pessimistic on AI, and you think it’s hype, that’s easy,” he said. In that universe, he added, “the tech sector is overvalued” and you should shift to value stocks.
A Safer Place
In either of these two paths — which Vanguard says are the likeliest of many possible futures — the old wisdom of diversified investing makes sense.
A standard asset allocation — one that might be a starting point in figuring out how much risk you want to take — is a so-called 60/40 portfolio, with 60% in stocks and the rest in bonds, invested entirely in broad index funds. While this kind of investing can be done with only U.S. securities, Davis suggests taking a global perspective. He doubts that “U.S. exceptionalism” is likely to last, counsels holding international securities and says no single portfolio is appropriate for everyone.
That’s close to my own view. I differ from Davis in that I try to stay away from active choices about the markets, and I don’t tilt one way or another, as far as growth or value stocks go. In my 401(k), I use mainly Vanguard index funds that represent the total global investable stock and bond markets.
Davis, on the other hand, told me he has “high risk tolerance.” In his own Vanguard 401(k), he favors actively managed funds with a bias toward value stocks. Like the index funds for which Vanguard is best known, its actively managed funds tend to be low cost.
Sticking with the markets when you are worried about them requires enough discipline — or faith — to fly blindly while the world churns, trusting that the future will resemble the past sufficiently to generate reasonable returns. I’m hoping for the best, and hedging my bets.