A stable long-term economic outlook means that JP Morgan Asset Management is expecting decent returns for many asset classes over the coming decade.
This is the conclusion of the asset management house’s 23rd edition of its Long-Term Capital Markets Assumptions report, which offers a set of projections about how 50 major assets classes around the world will perform over the next 10 to 15 years.
Strategists at JP Morgan Asset Management (JPMAM) estimate that real global growth will amount to 2.5 per cent annualised on average for the next 10 to 15 years. This forecast is unchanged from last year; the report adds that “the growth outlook is stable and risks are balanced”, despite a few adjustments at the country level.
Selected Long-Term Capital Markets Assumptions (LTCMA) forecasts (%)
Source: JP Morgan Asset Management; estimates as at 30 Sep 2017 and 30 Sep 2018
Against this backdrop, the group added that its equity return expectations are “little changed” from its 2018 while the forecast for global government bond returns is slightly higher. Of course, these outlooks come at a time when many investors are considering when the current market cycle will come to a close.
John Bilton, head of global multi-asset strategy at JPMAM, said: “Our 2019 assumptions come at a time of intense speculation about when the current cycle of economic expansion may end.
“While trying to precisely time the downturn is likely futile, understanding the complexities of the late cycle and preparing for the next phase is a vital exercise. To manage headwinds and capture opportunities in the coming years, investors need to evaluate and optimise existing investment frameworks to better reflect tail risks.”
Recent editions of the Long-Term Capital Markets Assumptions report have seen steady falls in the expected returns from equity markets but that negative trend has been broken this year. This year, JPMAM’s equity return assumptions “generally hold firm”, with developed markets left unchanged, emerging markets revised up and the US slightly down.
“In 2018, with the exception of the US, developed and emerging equity market indices trended sideways to slightly negative, drifting below our estimates of long-term returns,” the report said. “That provides valuation support to our projected returns, but it is tempered by a larger drag from margin normalisation.”
The group’s long-term expectation for developed market (DM) equity returns has been left at 5.5 per cent annualised in local currency terms while the outlook for emerging market equity has been lifted from 8 per cent to 8.5 per cent.
As noted, the expectation for long-term returns in the US equity market has fallen from 5.5 per cent to 5.25 per cent on the back of JPMAM’s cut to its US inflation forecast and increased drag from margin normalisation – or the rebalancing of companies’ profits and wages.
International revenue breakdown for G4 markets
Source: JP Morgan Asset Management, Thomson Reuters Datastream. Data as at Aug 2018
When it comes to the UK, JPMAM said it cannot predict exactly how 2019’s Brexit will affect the economy but argued that the effect on the stock market should be “fairly muted” as a large proportion of its earnings are linked to international rather than domestic growth. Recovering earnings, especially in the resources sectors, has seen the UK’s long-term equity forecast move from 5.5 per cent to 5.75 per cent annualised.
In the eurozone, the asset management house has revised its long-term equity forecast by 25 basis points to 5.75 per cent in euro terms. The report said that this upwards revision is largely down to a lower starting valuation level, but also takes into account reduced expectations of return on equity on the continent.
The report is also favourable towards Japanese equities, arguing that governance-led reforms being carried out as part of the government’s Abenomics programme are likely to drive a sustainable increase in capital returns to shareholders. Japanese equities are expected to grow by an annualised 6.75 per cent, in dollar terms, over the coming 10 to 15 years.
Emerging market equities have seen the largest upgrade in the new report; the asset class is expect to offer a 300 basis point return premium relative to developed markets, which is a 50 basis point increase on the previous forecast. This means JPMAM sees emerging market stocks as making an annualised 8.5 per cent dollar return over the long term, based on lower starting valuations and expectations of higher revenue growth.
The report added: “One factor that unites both developed and emerging market equity is that stock markets in general are a lightning rod for de-risking when the economic cycle turns. So while investors must judge both how much risk to carry in late cycle and how far the cycle could run, we would reiterate that the equilibrium return assumptions for global equities are stable and reasonably attractive.
“A crucial consideration for any long-term investor in 2019 will be the trade-off between how much to continue to attempt to extract returns from risk assets in this cycle and how much ‘dry powder’ to try and keep for the next one.”
When examining the outlook for fixed income, JP Morgan Asset Management strategists noted that the defining theme for bonds over the past 12 months has been the flattening of the yield curve that comes with the tightening of monetary policy in the US.
The group’s forecast has government bonds in the US, UK, eurozone and Japan all witnessing lower yields. While some are expecting a bond bear market, JPMAM argued that dovish inflation outlook and anticipation of extended periods of stimulus over the coming 15 years suggests lower rates and flatter yield curves.
Developed market equilibrium yield and return estimates (10- to 15-year return assumptions, local currency, %)
Source: JP Morgan Asset Management; estimates as at 30 Sep 2018
“A key component of our framework for long-end yield assumptions is that quantitative easing [QE] is likely to be a part of the conventional central bank tool kit. Central banks have added QE and forward guidance to their monetary policy tools, and we believe these are here to stay in future downturns,” the report said.
“Indeed, we think that QE will probably be used again over our forecast horizon. This is expected to keep term premia depressed, implying that curves remain flatter in equilibrium than experienced during the last 15 years.”
Finally, JPMAM’s Long-Term Capital Markets Assumptions report examined the outlook for alternative assets and concluded that they are “a relative, and in some cases an absolute, bright spot” in its updated forecasts.
The outlook for private equity has been raised from last year’s assumptions, thanks to a better operating environment for those investing in disruptors, a growing geographic opportunity set and “ample opportunities” for portfolio exits.
Meanwhile, long-term assumptions for direct lending, hedge funds, real estate and infrastructure are much the same as they were in the previous report while the return outlook for commodities has been downgraded.
That said, JPMAM expects investors to continue to allocate more towards alternative assets in the near term as they seek enhanced returns – although this will likely drive up valuations and eventually weigh on future returns.
“This prompts us to repeat our refrain that manager selection is the primary determinant of return across alternatives,” the group concluded.
“Compensation for illiquidity and a modest boost to our alpha assumptions may get investors part of the way to their return aspirations in alternatives, but there really is no substitute for manager due diligence – especially given where we are in the economic cycle.”