During a webcast, members from the J.P. Morgan Asset Management Assumptions Committee shared their research on the future of these assumptions. The team used quantitative optimization techniques to arrive at their recommended portfolios that account for asset liquidity–or illiquidity–and its impact on “real-world” investment results.
David Shairp, global strategist in the Global Multi-Asset Group explained there are likely to be shorter, choppier business cycles and reduced growth expectations during the next several years. He also stated there will be at least three recessions in the next 10 years alone.
Fixed income returns are likely to be hurt, as yields rise toward expected higher “equilibrium” levels. This means there will be a long “normalization” period in a zero interest rate environment. Also, real returns on U.S. Treasuries are likely to be negative over the investment horizon. On the other hand, equity returns are set to benefit from higher starting dividend yields, and emerging markets are likely to remain top performers. Real estate is also on track to have promising returns.
Anthony Werley, chief strategist, Endowments & Foundations Group, explained the Committee predicts the developed world consumer price inflation will remain low over the next 10 to 15 years. Werley states, “The inflation outlook is a tug of war, as headline inflation should outstrip core inflation.” He also predicts the developed economy wage growth will remain subdued structurally. The commodity price inflation will be drive by the demand of the robust emerging market.
According to Michael Feser, head of Quantitative Research and Portfolio Management, Global Multi-Asset Group, an aging population will put downward pressure on developed market equity valuations over the long term, but “differences in investment behaviors across wealth distribution cohorts should temper the impact. Shifts in corporate pension plan allocations are, however, expected to be a stronger negative.” The change in demographics will be modestly negative for the equity markets, but not to the extent implied by life cycle models and the asset meltdown hypothesis, states Feser. Private pension funds will create further headwinds, as they reduce equity holdings. Global capital flows should be able to provide some buoyancy, however, not enough to offset downward equity valuation pressures.
Feser adds, cash bond yields are expected to be stable for the next three years, followed by a four-year adjustment period towards the equilibrium yield of 3% for cash and 5% for U.S. 10-year Treasuries. “Cash returns are projected to be adversely impacted by the Fed’s accommodative policy and the investor demand for safety, returning 2% in nominal terms and -0.75% relative to core inflation. Fixed income returns will suffer during the period when yields rise towards equilibrium levels and we expect U.S. 10-year Treasuries to return 2% over the forecast horizon, in line with cash.”
Assumptions show the yield curve between cash and 10-year U.S. Treasuries to be slightly steeper than in the past. This reflects a slight inflation bias and incorporates Japan’s experience following an extended period of zero interest rates. The Committee however, expects the long end of the yield curve, between the 10-year and 30- year maturity, to flatten to 25bps in equilibrium due to strong structural demand in long duration bonds.
Based on the Committee’s research, the conclusions they came to show the economic recovery is under severe pressure and multi-year deleveraging in the developed world is likely to keep global growth below prior trend rates, and markets will deliver moderate real returns versus history, despite depressed starting levels. Also, today’s high levels of spare economic capacity are likely to persist for years, keeping inflation and interest rates low, but aggressive central bank stimulus should eventually push inflation and yields higher as conditions in the global economy normalize. Emerging economies will remain on a strong secular growth trend, with emerging markets outpacing developed markets by a wide margin. However, alternative investments and real assets are also important for their diversification benefits, and their ability to produce high Sharpe ratios, relative to traditional assets.
J.P. Morgan Asset Management Long-term Capital Market Return Assumptions are developed each year by the firm’s Assumptions Committee, a multi-asset class team of senior investors from across the firm. The Committee relies on the input and expertise of a range of portfolio managers and product specialists, striving to ensure the analysis is consistent across asset classes. The final step in the process is a rigorous review of the proposed assumptions and their underlying rationale with the senior management of J.P. Morgan Asset Management.
A replay of the webcast can be viewed at www.jpmorgan.com/institutional. The full white paper, titled “Long-term Capital Market Return Assumptions” will be available online in two weeks.