There are 2 reasons why the stock market is set to underperform in the next few years, according to Vanguard's CIO

• US stocks are set to underperform, according to Vanguard's chief investment officer.
• The firm estimated the S&P 500 would yield between 4.7%-6.7% over the next few years.
• That's well below its recent average, thanks to two dynamics that are weakening the outlook for equities.

US stocks are poised for a disappointing performance over the next few years, according to Vanguard chief investment officer Greg Davis.

In an interview with CNBC on Friday, he estimated that stocks would yield below-average returns for investors over 2024 and the following years, averaging 4.7%-6.7%. That's well-below earlier returns for the S&P 500, which ranged around 9%-10%. 

There are two reasons why US stocks are set up for those lackluster returns, Davis said:

1. Valuations are too high. 

Much of the growth seen in US stocks recently has largely been due to valuation expansion – but valuations can't keep soaring forever, Davis said, especially considering that markets are exiting the Great Moderation, a period when interest rates were ultra-low, financial conditions were loose, and stocks enjoyed steady returns.

US stocks outperformed international stocks by around 8 percentage points over the last decade, Davis said, a trend that's unlikely to last. The Fed has aggressively raised interest rates to quell inflation in the last year and a half, which already sent stocks tumbling in 2022.

Vanguard predicted US stocks would return around 5% annually over the next few years, while international stocks return around 7%-9%.

2. The risk premium in the stock market is too low.

The equity risk premium in the US stock market, which is the excess return when investing in stocks over the risk-free rate, is around 2 percentage points lower than the long-term average, Davis. That speaks to US bonds becoming a more attractive investment option, with the yield on the 10-year Treasury hovering close to 5% over the past month.

The opposite is true in international markets, where the equity risk premium actually makes stocks more attractive than bonds. 

"What are you being paid to invest in equities relative to a 10-year Treasury? In the US market, it's not as compelling," Davis said.

Investors appear to have picked up on that, with weekly flows in US equities turning slightly negative over the past three weeks, according to Bank of America data.

Meanwhile, some forecasters have cautioned investors on the outlook for the equity market. The economy is flashing signs of weakness under the surface, some market veterans say. That could potentially signal a coming recession.