Historically low government and investment grade bond yields and high stock valuations mean that asset allocators will face significant challenges to achieve strong returns. The initial “normalisation” of yields will weigh on fixed income markets, while elevated equity valuations will likely restrain stock market performance.
The reason for reduced expectations lies in the massive central bank monetary stimulus measures which saw policy rates cut to negligible levels and provided the liquidity to induce a remarkable recovery in stock prices since March.
Although their response, together with fiscal spending by governments, might eventually help the global economy get back on track, the effect on future asset prices is likely to be more complex.
The enormous and thus far successful efforts of policymakers and governments to absorb the economic shock of the global pandemic will have a lasting imprint on capital markets, with greater government involvement in achieving economic objectives set to be a fixture of the next decade, according to JPMAM’s 2021 Long-Term Capital Market Assumptions (LTCMAs), a report that outlines the average annual returns investors can expect for more than 200 major asset classes over the next decade.
“Our macro forecasts for global economic growth [2.4%] and inflation [2.2%] remain largely unchanged despite the pandemic. This is a testament to the unprecedented interventions by central banks and governments around the world in response to Covid-19, which will be felt in asset pricing implications for years to come,” said Sylvia Sheng, global multi-asset strategist at JPMAM, in media webinar last week.
Real growth projections are modestly higher this year, with the forecast for global growth up 10 basis points (bps), at 2.4%, over the next 10 to 15 years. The emerging market forecast is unchanged, at 3.9%, with the slight dip we see in trend growth offset by a cyclical recovery bonus. Within Asia, China’s growth forecast remains unchanged at 4.4%, while forecasts for Korea and India are down by 10bp each to 2.1% and 6.9%, respectively.
Value in Asia
The impact of elevated valuations is most stark for US large-cap equities, where JPMAM’s return forecast falls by 1.5%, to 4.1%. This pulls global equity returns down by 1.2%, to 4.8%, while global equity ex-US forecast is down 0.7%, at 5.8%, implying better forecasts for returns for some non-US markets.
“Lower future returns across the board will mean that investors need to seek out new sources of returns and income beyond traditional asset classes. With little prospect of positive real returns on developed market bonds, investors may consider paying attention to higher-yielding parts of credit markets including Asian and emerging markets debt, income-generating alternatives, and higher-returning emerging equity markets such as Asia (ex-Japan),” said Patrik Schöwitz, global multi-asset strategist, JPMAM at the webinar.
Indeed, emerging market Asia equities look attractive compared with developed market equities, offering a 2.1% return premium. In particular, return forecasts for China A-shares, Taiwan and Korea equities are at 7.5%, 7.1% and 6.4%, respectively, compared with 4.9% in developed market equities, in US dollar terms.
Within fixed income, given extremely low starting yields, JPMAM expects most developed market government bonds will deliver negative real returns over the next 10 to 15 years.
“Global central banks are committed to low rates for an extended period, have pushed out any expectation for rate normalisation to at least 2024,” said Sheng.
However, emerging market government bonds continue to offer positive returns at 5.2% for both emerging market debt in hard currency and local currency terms.
“Credit remains the bright spot within fixed income. Return forecasts for emerging markets and Chinese corporate bonds are at 4.7% and 5.6%, while 2.5% for US investment grade corporate bonds and 4.8% for US high yield corporate bonds,” said Sheng.
The LTCMA also assumes that the US dollar will depreciate against major currencies over the next decade, including the Euro, Japanese Yen and the Chinese Yuan.
“Conviction is driven by the US dollar’s expensive starting valuation and relatively higher expected inflation in the US than in the Eurozone and Japan,” said Sheng.
Seeking alternatives
Alternatives might also present asset allocators with opportunities.
The authors of the LTCMA predict that returns for core real estate will rise by 0.1% in the US and in Asia-Pacific, to 5.9% and 6.6%, respectively, while European-ex UK core real estate is unchanged at 5.0%.
Meanwhile, “infrastructure and transportation offer standout returns to investors, with global core infrastructure equity returns up 0.1%, to 6.1%, and global core transportation at 7.6%,” said Schöwitz.
On the other hand, hedge fund strategy projections have come down this year, reflecting lower returns available in public market assets.
“Nevertheless, we believe that conditions for alpha generation are improving, which will heighten the importance of manager selection,” said Schöwitz.
Stock-bond frontiers: 2021 assumptions (US dollars)
