4 Sensible Return Forecasts in an Odd Market
Investors are working in an odd global market. Some regional equity markets have been hitting records or nearing their records, even in the midst of slowing economic growth, lower interest rates, stagnant inflation and a trade war. Yet we think some of the aforementioned investment trends can serve as an anchor to create sensible five-year return forecasts. Here are four of them from our Capital Market Assumptions Five-Year Outlook to help investors position their portfolios.
Developed Market Equities: 5.7%
This falls well below the 8.8% five-year actual average annualized return. Slow revenue growth — consistent with a shifting global economic model because of political and technological developments — will be further pressured by some negative profit translation (the impact of profit margins and share count when “translating” revenue growth into earnings growth). Share repurchases will remain elevated but will be unable to offset lower profit margins, wherein cost increases — albeit muted — will eat into profits in a low top-line growth environment.
When analyzing relative factor valuations on a price-to-book basis (relative to history), value continues to stand out as attractively priced. However, we acknowledge that the value factor has been inexpensive for some time now — and it is difficult to predict when it will start to “work” again. Value has one of the longest cycles of any factor, and those invested in value strategies should have the ability and wherewithal to withstand cyclical underperformance.
Emerging Market Equities: 6.1%
Investors should expect just a modest return premium for emerging markets over developed markets and they may have to be selective. Our forecasts falls somewhat short of the five-year average emerging markets equity return and is a material reduction from last year’s forecast of 8.3%. We expect global restructuring and the trade war to hurt the region’s return potential. Still-superior revenue growth will be muted by continued (and well-documented) share issuance. Valuations, while inexpensive, are not expected to move higher given greater uncertainties surrounding current economic models — particularly China’s.
Global Investment Grade Bond: 2.1%
This is down from our 2.7% forecast last year and well short of the 3.8% actual five-year return. The shifting global economic model, persistently low inflation, and the struggle by central banks to stay relevant has lowered longer-dated interest rates over the past year and has set the stage for a new global easing interest-rate cycle in the years to come. This was kicked off by the Federal Reserve’s rate cut in July.
For complete asset class forecasts, download the full paper.
We think investors should look for interest rates to be lower than what the market is predicting. Because of that, we anticipate total returns will continue to outpace the low yield starting point given the capital appreciation generated by future interest rates falling short of expectations. Specifically, for the global aggregate investment grade bonds, we expect the 1.5% starting point yield will translate into a 2.1% annualized total return. A similar dynamic is at play for our regional fixed income forecasts.
Global High Yield Bonds: 4.8%
Lower starting point yields will put high yield below the 5.2% five-year average return. Further, global high yield’s credit element (think defaults) leads to five-year annualized returns below starting point yields — historically representing a 1.3% hit. We are expecting a similar hit over the next five years, with the current 5.8% starting point yield translating to a 4.8% return expectation. That said, lower interest rates will both drive the ongoing search for yield and support asset class fundamentals, as lower interest rates equate to an easier ability to service and roll over debt.
The 5-Year Portfolio
All-in-all, our five-year forecasts call for a 4.7% annualized return for a portfolio invested 60% in global equities and 40% in U.S. investment grade bonds, versus a realized 5.2% annual return over the past five years. It’s enough to beat out stubbornly low inflation, but it represents a moderate return outlook after a decade of much stronger returns.
Learn More from Jim McDonald
Register for the September 18 webinar The Next 5 Years: What Investors Can Expect, featuring Jim and Chief Investment Officer Bob Browne, CFA.
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