We have lowered many of our capital market assumptions in our latest quarterly update. We now assume lower U.S.-dollar returns from most asset classes over the next five years, following a fall in both yields and global growth expectations.
Our five-year return assumptions have steadily moved lower since the financial crisis, amid weak global growth prospects, easy monetary policy and rising valuations. Most are now well below long-run averages.
We have lowered our assumed returns for most fixed income assets, following a drop in yields (and rise in valuations) in the second quarter. We see holders of long-duration U.S. Treasuries losing more than 1% annually over the next five years as yields rise. Our analysis also shows less than 10% of the global fixed income universe offering annual returns of 3% or more over the next five years, with the higher returns concentrated in riskier assets such as hard-currency emerging market (EM) debt and high yield. We view EM debt as especially attractive versus Treasuries over the next five years.
Our return assumptions for U.S. stocks are unchanged — but are low from a historical perspective due to high valuations (the U.S. market is currently trading near 19 times earnings). We see non-U.S. equities offering higher potential returns, along with higher risk. We have, however, downgraded our return assumptions for pan-European stocks due to the likely impact of a Brexit on UK and eurozone economic growth. To generate higher returns, investors must be ready to accept more market risk or more illiquidity risk (e.g. alternatives). Within riskier assets, EM debt and dividend growth are worth considering. Government bonds can still play an important diversification role in portfolios — but at a greater cost. We see investment grade credit offering attractive risk-adjusted returns for investors looking for safety.
|July 27||Federal Open Market Committee (FOMC) meeting announcement|
|July 28||UK GfK Consumer Confidence|
|July 28-29||BoJ monetary policy meeting|
|July 29||U.S. gross domestic product (GDP), U.S. Employment Cost Index; eurozone GDP, eurozone inflation; results of European Banking Authority (EBA) stress test|
The Fed is expected to remain on hold this week, but the market is pricing in higher probabilities of September and December Fed interest rate hikes than it did immediately after the Brexit vote. We believe the bar for a September move is high, as the Fed will likely need more time to evaluate the status of the U.S. economy post Brexit. We could see the BoJ delaying any additional qualitative and quantitative easing in favor of coordinating it with the announcement of a fiscal package in September. This week will also be a tough test for U.S. sales growth, as many U.S. energy and materials companies report results. The EBA stress test results of European banks are an important check-up on Italy’s weak banking system.
Weekly and 12-month performance of selected assets
|Equities||Week||YTD||12 Months||Div. Yield|
|U.S. Large Caps||0.6%||6.4%||2.9%||2.1%|
|U.S. Small Caps||0.6%||7.7%||-2.1%||1.4%|
|Asia Ex Japan||0.4%||6.8%||-4.6%||2.6%|
|U.S. Investment Grade||0.3%||8.7%||8.8%||2.8%|
|U.S. High Yield||0.3%||12.4%||5.6%||6.6%|
|Emerging Market $ Bonds||0.0%||12.5%||11.6%||5.1%|
|Brent Crude Oil||-4.0%||22.6%||-18.6%||$45.69|
Source: Bloomberg. As of July 22, 2016. Notes: Weekly data through Friday. Equity and bond performance are measured in total index returns in U.S. dollars. U.S. large caps are represented by the S&P 500 Index; U.S. small caps are represented by the Russell 2000 Index; Non-U.S. world equity by the MSCI ACWI ex U.S.; non-U.S. developed equity by the MSCI EAFE Index; Japan, Emerging and Asia ex-Japan by their respective MSCI Indexes; U.S. Treasuries by the Barclays U.S. Treasury Index; U.S. TIPS by the U.S. Treasury Inflation Notes Total Return Index; U.S. investment grade by the Barclays U.S. Corporate Index; U.S. high yield by the Barclays U.S. Corporate High Yield 2% Issuer Capped Index, U.S. municipals by the Barclays Municipal Bond Index; non-U.S. developed bonds by the Barclays Global Aggregate ex USD; and emerging market $ bonds by the JP Morgan EMBI Global Diversified Index. Brent crude oil prices are in U.S. dollars per barrel, gold prices are in U.S. dollar per troy ounce and copper prices are in U.S. dollar per metric ton. The Euro/USD level is represented by U.S. dollar per euro, USD/JPY by yen per U.S. dollar and Pound/USD by U.S. dollar per pound. Index performance is shown for illustrative purposes only. It is not possible to invest directly in an index. Past performance is not indicative of future results.
Views from a U.S. dollar perspective over a three-month horizon
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