The risk of a large-scale correction in US stocks is on the rise, say researchers from Vanguard Group. They warn the probability is 30 percent higher than what has been typical over the past sixty years.
Vanguard's chief economist Joe Davis said investors do need to be prepared for a significant downturn which is now a 70 percent chance.
"It's about having reasonable expectations," Davis said. "Having a ten percent negative return in the US market in a calendar year has happened 40 percent of the time since 1960. That goes with the territory of being a stock investor."
The economist added, “It’s unreasonable to expect rates of returns, which exceeded our own bullish forecast from 2010, to continue.”
In its annual report, the company told investors to expect no better than four to six percent returns from stocks in the next five years. Some indicators suggest "a little froth" in the market.
"The risk premium, whether corporate bond spreads or the shape of yield curve or earnings yields for stocks have continued to compress,” said Davis. "We're starting to see, for the first time… some measures of expected risk premiums compressed below areas where we think it can be associated with fair value."
Overreaching is no better a solution for a lower-return environment than getting out of the market entirely, according to the economist. He expressed worries that after hearing "lower returns," some investors will view that as a catalyst to become more aggressive to generate the returns they have been used to in recent years.
“You need to stay invested, because of lower expected returns," Davis said, adding "Don't become overly aggressive. The next five years will be challenging, and investors need to have their eyes wide open."
US stocks have been on a roll since Donald Trump’s presidency. They have reached multiple record highs this year, with the Dow adding more than 23 percent, the S&P 18 percent and the Nasdaq Composite 28 percent.