Multi-Asset Blog

Reassessing Return Expectations: Mid-2022 Update

03 August 2022

5 min read

Inigo Fraser Jenkins| Co-Head—Institutional Solutions

Suresh Iyer, CFA| Strategic Asset Allocation Research—Multi-Asset Solutions

Given the huge changes in inflation expectations and abrupt yield changes of the past six months, it seems sensible to re-assess expectations for capital market returns. Long-term investors update and review long-term strategic assumptions on a set cycle, which we see as the right way to deal with the difficulties of making forecasts that stretch far into the future. However, we suggest that there should be flexibility to review these forecasts when large shifts take place. In our view, now is such a time.

Market Moves Have Boosted the Return Outlook

A decline in valuations and a slight upward shift in long-term expected inflation in our model (though inflation is still projected to be moderate) has increased the return outlook for equities and real assets. Rising yields, meanwhile, have boosted fixed-income expected returns, though real returns are still expected to be muted versus their historical averages.

Inflation’s peak in the current cycle has moved higher and later than was expected only six months ago, increasing expectations for the degree of central bank hawkishness. However, it’s vital to note that the forces driving short-term inflation forecasts (and central bank responses) differ from those driving inflation over the next five to 10 years, which is the key consideration for our capital-market assumptions. Much lower valuations in public markets also need to be reflected in return expectations.

Mid-2022 Forecast Update: Key Takeaways

In updating the projections from our systematic approach to forecasting capital-market returns over long horizons, we’ll also put them in the broader context of the changing investment environment. This provides a more qualitative backdrop, which we’ve detailed recently.

Here are key takeaways from our forecast update using AB’s proprietary Capital Markets Engine (CME):

Expected US inflation for the next 10 years has risen to 3.1%, and the nominal return expectations for many asset classes have also climbed (Displays 1 and 2).
Higher inflation expectations boosted inflation-adjusted real asset return forecasts to slight outperformance over equities (Display 3). In our recent strategic investment outlook, we explored the real asset outlook and note the potential difference between some commodities and broader real assets.
Increased yields have contributed to rising expected returns for fixed income (Displays 2 and 3).
The real expected return for a 60/40 stock/bond portfolio over the next 10 years is 1.2%, up from 0.8% in December 2021. However, this is still down significantly from the 3.2% average since 1988.

Display 1: Projected Annualized Nominal Return Ranges: 10 Years

Range of Compound Growth Rates: Returns Hedged to USD (Percent)

Projected annualized nominal return ranges for various assets over a 10-year horizon

Current forecasts do not represent past performance and do not guarantee future results or a range of results.
Hedged returns in US dollars. Returns above the line represent projections based on normal conditions. Equity markets referenced represent broad universes similar to the corresponding MSCI indices: for example, Global Equity represents a universe similar to the MSCI World. Global Sovereign Bonds referenced is for seven-year constant-maturity bonds.
Initial conditions as of June 30, 2022
Source: AllianceBernstein (AB)

Display 2: Annualized Nominal Risk/Return Projections: 10 Years

Returns Hedged to USD (Percent)

Table of projected nominal returns, normal returns and volatility over a 10-year horizon

Current forecasts do not represent past performance and do not guarantee future results or a range of results.
*Hedged returns in US dollars. Equity markets referenced represent broad universes similar to the corresponding MSCI indices: for example, Global Equity represents a universe similar to the MSCI World. The bond markets referenced are for seven-year constant-maturity bonds of the type named: inflation-linked sovereign, nominal sovereign, high-yield and investment-grade corporate. Hedge funds represent the diversified fund of funds. †Commodity futures represent the Dow Jones Commodity Index. ‡Real assets are modelled as one-third REITs, one-third commodity futures and one-third commodity stocks.
Initial conditions as of June 30, 2022
Source: AB

Display 3: Real-Return Outlook Is Higher for Most Risk Assets

10-Year Annualized Real Growth Rates Hedged to USD (Percent)

Current and 2021 year-end real return projections for select asset types

Data do not represent past performance and do not guarantee future results or a range of future results.
Hedged returns in US dollars. Equity markets referenced represent broad universes similar to the corresponding MSCI indices: for example, Global Equity represents a universe similar to the MSCI World. The bond markets referenced are for seven-year constant-maturity bonds of the type named: inflation-linked sovereign, nominal sovereign, high-yield and investment-grade corporate. Hedge funds represent the diversified fund of funds. Commodity futures represent the Dow Jones Commodity Index. Real assets are modelled as one-third REITs, one-third commodity futures and one-third commodity stocks.
As of June 30, 2022
Source: AB

Incorporating the Qualitative Context

The CME seeks to generate an internally consistent set of return expectations for a broad range of global return streams over strategic horizons, given observed market conditions and views on long-run equilibrium levels. It’s a quantitative model based on many simulations for macro building blocks such as inflation and real economic growth, as well as asset-class variables like valuation and profitability.

We believe that models like the CME are important foundations for forming market views, but it’s also important to put models in the context of broader assumptions. Inevitably, when regimes change (we believe this is happening now), other forces emerge that weren’t present when models were designed and parameters set.

Still, we find a good basis of agreement between our systematic starting point and views formed from a broader set of inputs. We’ll take a closer look at inflation and equity projections in the next sections.

The Battle Between Inflationary and Deflationary Forces

Based on our strategic views, we expect inflation to moderate from its current extremes as near-term pressures from commodity price shocks ease, supply-chain issues abate and tighter monetary policy starts to moderate rising prices. Over the long run, though, we expect inflation to settle at a higher level than the average over the last 20 years as inflationary and deflationary forces work against each other.

Deglobalization, an older population and shrinking labor force, higher unionization rates and a power shift from capital to labor will likely push inflation upward. We also see ESG as inflationary: consumers will likely be willing to pay more for “ESG-friendly” products, and restrictions in upstream capital spending in mining and energy will constrict commodity supply. The main inflationary channel of ESG will be the “S” component and its implications for higher wages. Finally, with debt to gross domestic product (GDP) at its highest level since WWII, it’s reasonable to expect that, perhaps implicitly, governments will prefer somewhat higher inflation as a way to control the debt burden.

On the other hand, powerful deflationary forces will remain: technological advances and automation. Savings rates should rise again, once the current pent-up spending wave ends and as lower nominal returns on savings combined with higher inflation implies a need to save more, which will lower the long-term velocity of money in the economy. We also see very few signs right now that long-run inflation expectations are becoming unanchored. Accounting for all these forces, we expect US inflation to be about 3% annualized over the next decade.

Equities: A Real Asset, Though Facing Margin Compression

The CME’s expected return for stocks closely matches expectations from a fundamental perspective. The fundamental lens decomposes long-run real equity returns into fundamental drivers such as dividend yield, buyback yield, real growth per capita, the change in profit share of GDP and changes in valuation multiples.

We believe that the profit share of GDP will shrink over strategic horizons; US corporations have recently taken an unusually large share of national output in the long-run historical context, and we don’t think this is sustainable. Taking deglobalization and increased labor bargaining power into account, we expect rising effective tax rates, inventory levels and employee compensation as a share of revenue.

However, we also assume limited multiple contraction—we expect future real interest rates to remain near today’s levels, which would still be low in a long-term context. Based on the current dividend yield, share buyback trends over the last 10 years, long-term real GDP growth and the United Nations estimate for long-run US population growth, we arrive at a 3.5% forecast for real equity returns.

Note: This content is intended for institutional investor use only. It is not intended for distribution to the general public.

The views expressed herein do not constitute research, investment advice or trade recommendations, and do not necessarily represent the views of all AB portfolio-management teams and are subject to change over time.

About the Authors

Inigo Fraser Jenkins

Inigo Fraser Jenkins is Co-Head of Institutional Solutions at AB. He was previously head of Global Quantitative Strategy at Bernstein Research. Prior to joining Bernstein in 2015, Fraser Jenkins headed Nomura's Global Quantitative Strategy and European Equity Strategy teams after holding the position of European quantitative strategist at Lehman Brothers. He began his career at the Bank of England. Fraser Jenkins holds a BSc in physics from Imperial College London, an MSc in history and philosophy of science from the London School of Economics and Political Science, and an MSc in finance from Imperial College London. Location: London

Suresh Iyer, CFA

Suresh Iyer is a Vice President within the Multi-Asset Solutions Group and is responsible for Strategic Asset Allocation Research. He also owns the Capital Markets Engine. Prior to joining AB in 2021, Iyer worked in the Prime Finance group at J.P. Morgan. Before that, he worked at Commonfund (CF), where he owned the CF Capital Markets Engine and conducted research on cyclical forecasting, tactical asset allocation (TAA) and risk. Iyer began his career within Deutsche Bank's Quantitative Research team, which spun out to form QS Investors, where he focused on portfolio construction, including risk models, optimization and transactions cost analysis, and was the lead researcher on the global macro multi-asset fund. Iyer holds an MS in computational finance from Carnegie Mellon University and a PhD in mechanical engineering. He is a CFA charterholder. Location: New York

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