Our capital market assumptions for the next 10 years reflect that we are in the early stages of a significant and far-reaching macroeconomic regime change that was set in motion over the past three years.
A mismatch between high demand (driven by monetary stimulus) and impaired supply in the wake of the pandemic and the war in Ukraine, on top of longer-term demographic, geopolitical and economic shifts, caused inflation to spike.
The US Federal Reserve and other central banks responded by raising interest rates and moving from quantitative easing to quantitative tightening.
While we are past peak inflation, we believe the risks of bouts of inflationary shocks over the next decade have increased.
In our view, this new period will be marked by labour scarcity, commodity under-investment, increased geopolitical uncertainty, and a move away from globalisation and toward 'friend-shoring' (ie trade partner selectivity).
Stubbornly higher inflation will likely result.
We also factor in higher interest rates and lower real economic growth than in the last cycle in US and global economies.
We believe greater volatility of macroeconomic factors and the global business cycle will also lead to more frequent cycles of slowdown and expansion versus what investors became accustomed to in the prior 35 years.
In turn, this drives several notable aspects of our 10-year assumptions that differ from the prior decade, including higher yields, generally lower multiples and higher premiums for risk assets.
A closer look at fixed income
We expect fixed income returns to be higher over the next 10 years, and this assumption centres on the higher starting point for yields that exist today.
As inflation has risen, the Fed has engaged in one of its most aggressive rate-hiking cycles ever, which raises forward-return prospects across the fixed income universe.
Our expectation is that inflation will settle out around 3 per cent, driven by prevailing supply-side shortages in goods, commodities, housing and labour.
The Fed will have difficulty achieving its old, and likely outdated, 2 per cent inflation target on a sustained basis.
As such, we do not expect the return to normalisation that the general market anticipates.
A closer look at equities
While yields are a rising tide that we expect to lift fixed income returns across the board, our expectations for equities are more subdued.
During the prior decade, earnings grew strongly, profit margins expanded, and multiples climbed.
However, quantitative easing and accommodative monetary policy are gone, while growth is slowing.
Slowing labour force growth will hold back economic growth, absent a strong revival in productivity.
One development we are watching that could influence productivity is artificial intelligence, with some observers estimating that productivity gains in AI could offset the expected decline in the labour force.
Our 10-year expectation for US real GDP growth is 1.6 per cent, down 0.5 percentage points from the prior decade.
Global GDP growth is also expected to be lower than the prior decade at 3.1 per cent, down 0.6 percentage points from the pre-pandemic trend.
