Less than one year ago – in the depths of the pandemic – forecasters were grappling with the risk that Covid-19 would leave in its wake high and lingering unemployment, widespread bankruptcies and a lasting erosion in the willingness of households and businesses to spend.
Reality proved far more benign. After a short, sharp downturn, the global economic recovery is going strong. It was helped at first by overwhelming policy support and later by a surge in capital spending and the unleashing of pent-up consumer demand. But even as the economy has suffered limited scarring, policy interventions at the height of the crisis will have a lasting impact.
Against this backdrop, our 2022 Long-Term Capital Market Assumptions (LTCMAs) explore how the legacy of the pandemic – limited economic scarring but enduring policy choices – will affect the next cycle. Over our investment horizon, we see modestly higher nominal global growth – 3.3% for developed markets, comprising a real GDP forecast growth of 1.5%. For the first time in many years we have raised our long-term inflation projections, expecting 1.8% inflation over our investment horizon.
Ultimately, our message is optimistic: Despite low return expectations in public markets, investors who are willing to expand opportunity sets and embrace sources of risk premia beyond traditional assets can still find sources of alpha to generate robust and efficient portfolio returns.
Our nominal growth forecasts rise a little this year in developed markets and we anticipate more two-sided risks to inflation. We expect policy rates to rise slowly, lagging nominal growth and leaving returns for cash and most developed market government bonds negative in real terms.
In our forecast, global equity returns decline 10 basis points, to 5% in USD terms. It’s a modest drop even after a year of strong returns since our last publication.
Adjusting for today’s sector mix implies better margins and more supported valuations than history alone suggests. We forecast an unchanged 4.1% annual return for US large-cap equities and a 6.6% return for emerging market equities, 20bps lower than last year.
We make a significant upgrade to our eurozone equity assumptions, from 5.2% to 5.8% in local currency terms. The market has greater exposure to the tech and luxury goods sectors, which both have a secular-growth quality that will likely garner high valuations. At the same time, the market is less exposed to the commodity and financial sectors.
Look further afield for attractive returns
The larger message is unmistakable: Investors need to look further afield to generate asset returns – both geographically and beyond public markets. They must also search harder for yield, evaluating and accepting trade-offs in terms of volatility and illiquidity.
Investors increasingly appreciate the benefits of alternative assets – improving alpha trends, the ability to harvest risk premia from illiquidity and the opportunity to select managers that can deliver returns well above what is available from market risk premia alone.
Financial alternatives offer an especially marked uplift compared with public markets, with our cap-weighted private equity projection up 30bps from last year, at 8.1%, and private debt offering 6.9%.
Active allocation, manager and security selection are key
Our forecasts tell us that investors can still achieve ‘acceptable’ returns. But the portfolio required to generate these returns is dramatically different than it has been in the past.
In our LTCMA projections published after the global financial crisis, a 60/40 portfolio of global equities and US aggregate bonds delivered a 7.5% return with expected volatility of 8.3%. Today, the same 60/40 portfolio is set to return just 4.3% with volatility of 9.7%.
Nevertheless, using our projections, we believe a return of north of 7% is still achievable even if the portfolio will look rather different: a lot more high yield debt, international stocks and alternatives and a lot fewer government bonds.
Lengthening time horizons and careful liquidity planning are non-negotiable elements of investing today. Ultimately, to push fully toward historical return levels, active allocation, manager selection and security selection will need to form some part of every investor’s toolbox.
While the destination is the same, the journey is tougher.
John Bilton is head of global multi asset strategy at J.P. Morgan Asset Management. The views expressed above are his own and should not be taken as investment advice.