Long-term asset class assumptions: markets presenting attractive entry points
At the end of each year, many Wall Street institutions and research firms publish their “Long-Term Capital Market Assumptions” reports. Among other things, these reports contain long-term (5+ years), annualized forecasts for asset class returns, risk, and correlations.
Asset class assumptions are not an exact science. In fact, in the short run, these forecasts will almost certainly prove incorrect. But in the long run, they can provide significant value for the development of strategic asset allocations. History has shown that resilient multi-asset class portfolios are constructed with an eye toward expected returns, expected risk, and the interaction between asset classes.
Accuvest has compiled forecasts from many of the largest institutions in order to come to average annualized return and risk figures. Importantly, when designing a policy portfolio to weather the highs and lows of the coming market cycle, investors should consider a “robust” portfolio, rather than an “optimal” one.
Long-term expected returns and standard deviations are shown below:
Forecasts provided by JP Morgan, State Street, BlackRock, Research Affiliates, Invesco, BNY, Morningstar
Market Downturn Has Improved Expected Returns
Compared to last year’s expectations, this year’s capital market assumptions are significantly improved.
In late 2021, return assumptions were below the historical average. At the time, equity market valuations were rich, interest rates were pushing down on the zero lower bounds, inflation was accelerating, and global economic activity was peaking. Now, after a historically bad year for balanced portfolios, lower valuations, higher yields, and the accompanying unwind of many policy dislocations mean that markets now offer excellent long-term return potential.
The chart below shows the difference between last year’s and this year’s return expectations:
Portfolio Implications
The increase in expected returns has many implications for portfolios:
In fixed income, policy rates have normalized and bonds are once again a plausible source of income and diversification. Higher risk-free rates translate to improved credit return forecasts as investment-grade bonds now offer the highest yields in more than 10 years. To take advantage, Accuvest’s preferred approach is a held-to-maturity, laddered bond strategy. This approach allows portfolios to “lock in” and “extend out” attractive yields. Furthermore, by holding to maturity, portfolios can deliver predictable income while mitigating the risks of rising rates and re-investment.
In equities, projected returns have risen sharply. We anticipate that margins will likely recede from today’s levels but will not reverse completely to their long-term average. Absent a severe recession, the re-valuation of equities in 2022 presents investors with an attractive entry point to an asset class with attractive historical returns. Importantly, international developed and emerging market equities are expected to perform better than their U.S. counterparts. There are many reasons why, but the fact that international valuations are significantly lower than the US plays a significant role. In fact, emerging markets are approximately half the price of U.S. equities. Additionally, the U.S. dollar is more overvalued than at any time since the 1980s. Should the US dollar weaken, the FX impact on international stocks will be a significant component of the higher forecasted returns.
Finally, alternatives continue to offer appealing diversification benefits and long-term capital appreciation potential. Hedge Funds, Commodities, Private Equity, and Venture Capital all have positive expected returns, albeit with a higher risk profile. Alternatives have become significantly more affordable and accessible in recent decades and we believe that more exposure for traditional portfolios is warranted.
Remain Optimistic
The underlying patterns of economic growth and consumption are stable. Global demographic trends are positive, productivity is increasing and the assumptions that underpin asset returns – cycle-neutral real cash rates, default and recovery rates, and margin expectations – remain favorable.
It has been a difficult year for balanced portfolios, but we advise that clients remain invested, stay optimistic and accept price volatility to achieve their long-term investment goals. For investors sitting on the sidelines, the market is once again presenting attractive entry points across asset classes.
Disclosures: This information was produced by and the opinions expressed are those of Accuvest as of the date of writing and are subject to change. Any research is based on Accuvest proprietary research and analysis of global markets and investing. The information and/or analysis presented have been compiled or arrived at from sources believed to be reliable, however Accuvest does not make any representation as their accuracy or completeness and does not accept liability for any loss arising from the use hereof. Some internally generated information may be considered theoretical in nature and is subject to inherent limitations associated therein. Any sectors or allocations referenced may or may not be represented in portfolios of clients of Accuvest, and do not represent all of the securities purchased, sold or recommended for client accounts.
The reader should not assume that any investments in sectors and markets identified or described were or will be profitable. Investing entails risks, including possible loss of principal. The use of tools cannot guarantee performance. The charts depicted within this presentation are for illustrative purposes only and are not indicative of future performance. Past performance is no guarantee of future results. Actual results may vary based on an investor’s investment objectives and portfolio holdings. Investors may need to seek guidance from their legal and/or tax advisor before investing. The information provided may contain projections or other forward-looking statements regarding future events, targets or expectations, and is only current as of the date indicated. There is no assurance that such events or targets will be achieved and may be significantly different than that shown here. The information presented, including statements concerning financial market trends, is based on current market conditions, which will fluctuate and may be superseded by subsequent market events or for other reasons.