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Asset class return forecasts for the next five years and their implications for portfolio construction

June 2022
Marketing Material

Secular Outlook 2022

How will the investment landscape evolve over the next five years? In our Secular Outlook, we provide our return forecasts for all the major asset classes and analyse the powerful long-term trends that will transform the economy and financial markets.

01

Overview: return projections in the next 5 years

Dividing a portfolio’s investments more or less evenly between developed market stocks and bonds has proved a rewarding strategy over the past few decades. The annualised return investors have secured by pursuing this approach has been in the high single digits – gains that have come courtesy of steady economic growth, an almost continuous fall in interest rates and inflation, and relatively calm financial market conditions.

Yet our forecasts covering the next five years indicate investors will need to plot a different course to achieve a similar result. This will involve allocating less capital to the developed world, increasing holdings of emerging market assets, and investing far more in alternatives, particularly commodities and gold.

Asset class return projections in the next 5 years
asset class return
Source: Pictet Asset Management, forecast period 30.04.2022 - 30.04.2027

 

A key finding from our research is that returns from equity markets will fall victim to an unfavourable shift in the business cycle. The global economy is approaching the end of its post-Covid expansionary phase. Tighter financial conditions, a peak in US jobs growth and large output gaps all point to a recession this year or next. This has significant investment implications. There is a considerable difference between making an allocation to stocks in the lead-up to a slump and doing the same once recovery begins to take root. And that’s true even for those who invest over long time horizons.

Our analysis of the past 100 years shows that an initial investment in developed market stocks after the end of a recession delivers a price return of 10 per cent a year for the following five years; investing before a recession, as would be the case today, has by comparison typically delivered only a 4 per cent annualised return – a shortfall of some 6 per cent per year.

Luca Paolini and Arun Sai
Chief Strategist and Senior Multi Asset Strategist
illustrations_Authors.jpg

Another obstacle for developed equity markets is a looming squeeze on corporate profit margins. With wages and raw materials prices rising, more stringent regulations adding to the costs of doing business and the prospect of a rise in corporate taxation, margins can be expected to fall by a cumulative 10 per cent over the next five years.

But it is not only developed market stocks that will struggle to match their past performance. Developed government bonds will also labour to deliver what investors require of them over the next five years. Such securities have traditionally served as an anchor for a diversified portfolio – a crucial source of income and capital protection during periods of economic uncertainty.

Yet outside the US – where initial valuations for government and investment grade bonds are becoming more attractive thanks to this year’s spike in yields – returns from developed market fixed income will fall below inflation over the next five years.

Asset class returns - the next 5 years
Arun Sai, Senior Multi Asset Strategist

Source: Pictet Asset Management

Download the full investment outlook to read more on this subject

To make up for the lacklustre returns and income on offer from the developed world, investors will have to strike a delicate balance. On the one hand, our analysis indicates that, on average, portfolios will require higher allocations to stocks and bonds from emerging markets, as well as commodities – riskier investments that offer higher prospective returns. On the other, it would be prudent to accompany this dialling up of risk with a higher allocation to assets that do not move in lockstep with mainstream stocks and bond markets, such as liquid alternatives, gold and private assets.

Within emerging markets, Chinese stocks look particularly attractive while emerging market bonds’ income-generating potential should grow, enhanced by what we believe will be a steady appreciation in developing world currencies.

Among alternatives, non-energy commodities look especially appealing; their returns should be in excess of inflation over the next half a decade.

Our analysis also shows real estate and private equity both outperforming developed market equities over our five-year forecast horizon. Allocations to gold and infrastructure, meanwhile, make sense at this juncture as a means to diversify risk and protect portfolios against the possibility of stubbornly high – or volatile – inflation.

Investors can remain faithful to the traditional balanced portfolio of mainstream bonds and stocks but, in doing so, accept a lower return and potentially higher volatility.

The next five years, then, present investors with a conundrum. They can remain faithful to the traditional balanced portfolio of mainstream bonds and stocks but, in doing so, accept a lower return and potentially higher volatility. Or they can take a less familiar path and allocate more of the capital to alternative assets. Our analysis suggests, the second option is the wiser course.
02

Inflation's back (but the 70s aren't)

Inflation’s resurgence during the past year has awakened fears that the global economy has returned to the 1970s – a period when growth stagnated and central banks lost control of price stability. That’s too pessimistic a view.

We believe the 2022 inflationary surge will broadly prove to be relatively short-lived. But we also believe that inflation rates in major economies won’t be going back to the very low and very stable levels that had largely prevailed since the early 1990s.

SecularOutlook_Inflation

Instead, we expect the equilibrium rate to be slightly higher, with considerably higher volatility of outcomes – we see it ranging between 2 per cent and 3 per cent across much of the developed world, albeit with ever more frequent spikes higher and lower.

Crucially – and unlike during the 1970s – there aren’t many signs of inflation flowing through to wage demands. Wage demands  became embedded when inflation expectations started to rise. This time around, central bankers’ record of maintaining long-term price stability has kept them in check.

As supply bottlenecks caused by Covid start to unblock and the impact on commodity prices of Russia’s invasion of Ukraine begins to fade, price pressures will dissipate. But ultimately, inflation is determined by economic policy, which means it’s a political choice and politicians seemed to have learned past lessons of high inflation. 

03

The promise of Web 3.0

Tokenisation and digital assets
Shaniel Ramjee, Senior Investment Manager Multi Asset

Source: Pictet Asset Management

Did you know?
Already a USD50 billion market, NFT (non-fungible token) sales expected to grow more than
10%
every year through to 2030
Source: Emergen Research, February 2022
04

Covid and war: the long-term legacy

The past two years have brought not one but two generation-defining events – Covid and the war in Ukraine. Together, they will leave a far-reaching economic and societal legacies. 

The steady erosion of US supremacy, the green transition and a desire to build more resilient supply chains among both corporations and governments may have pre-dated the pandemic, yet all three trends look set to gain more momentum in the wake of Covid and Russia’s invasion.

In terms of fiscal policy, Covid and the war both point towards a surge in government spending, particularly in the developed world. That, in turn, will be funded by more borrowing, pushing up bond yields in both the developed and developing world.

At the same time, global central banks have proved that they can act together, at scale, and that they are not afraid to use innovative, complex tools to achieve their objectives. There is now a blueprint for future crises, with central banks having built a track record for providing liquidity not just to commercial banks but directly to the private sector.

Download the full investment outlook to read more on this subject
05

The demise of the Washington consensus and its effects on the allocation of capital

One of the most profound and far-reaching structural trends of the past decade – affecting society, politics and the economy - has been the slow but steady demise of the neoliberal world order and its economic counterpart the Washington Consensus. It is a phenomenon we have touched upon in previous Secular Outlooks, yet the Covid-19 pandemic and the Ukraine War have significantly accelerated the shift, which means it demands even closer scrutiny. 

In this section, we look at the impact the erosion of the rules-based global order is having on the financial market and analyse in particular how it has distorted the allocation of capital, which ultimately determines the return on investment. 

The neoliberal order came to prominence during the inflation-ravaged 1970s as an antidote to what governments saw as the policy failures of Keynesian economic thinking. In economic terms, this new order was built on six key pillars: 

  1. Fiscal policy discipline – or ‘small government’ characterised by strict control of public spending
  2. Tax reform, a broadening of the tax base and the adoption of moderate marginal tax rates
  3. Market-determined interest rates and exchange rates
  4. Liberalisation of goods and capital flows
  5. Privatisation of state enterprises and deregulation
  6. Strict enforcement of property and other legal rights

We look at how the erosion of rules-based global order has distorted the allocation of capital, which ultimately determines the return on investment.

And the new set-up worked. The global economy experienced a golden age characterised by rapid productivity gains, surging trade volumes and the emergence of China as new economic superpower. Financial markets also benefited enormously. Equities experienced one of their longest and strongest ever bull markets; risk premia collapsed to near zero;  bond yields fell sharply as inflationary pressures dissipated. 

But all this came to an end with the Global Financial Crisis (GFC) in 20081. The GFC ushered in a period of intense soul-searching among policymakers that resulted in a steady dismantling of the Washington Consensus and the re-emergence of a more interventionist state. The watershed moment was the introduction of quantitative easing in 2008-2009 by all major central banks through which they became the first and last-resort buyers of government bonds, effectively determining the real cost of capital for investors. QE was conceived as a temporary solution to an emergency situation.

But as the emergencies multiplied, not only did QE become the default setting but national governments – spurred on by voters – also embraced tighter regulation of the economy and finance.  As a consequence, the role of financial markets – efficiently channelling capital from savings to companies to maximize return and productivity with the least disruption and volatility – is now being tested.

 

Where are you planning to increase your allocation in the next five years?

Download the full investment outlook to read more on this subject