Northern Trust’s Capital Market Assumptions Working Group has updated the firm’s five-year capital market forecast, used both to promote industry discussion about risk and return and to inform strategic asset-allocation decisions.
Broadly speaking, Northern Trust expects relatively steady economic growth, controlled inflation and accommodative monetary policy. These forces will combine, according to the forecast, to drive “good-but-not-great” risk asset returns and “low-but-mostly-positive” fixed-income returns.
Mixing optimism and a temperate outlook, Northern Trust posits that global equity returns will remain below long-term averages, but they should also be higher than current valuations suggest. On the fixed-income side, the expectation is that mild growth and relatively tame inflation will keep interest rates low and yield curves flat globally. For real assets, Northern Trust expects performance in line with equities that also provides additional diversification benefits; similarly, alternative assets such as private equity and hedge funds are anticipated to continue to add some value by enhancing risk-adjusted returns.
Developed markets will hum along
The capital market forecast report suggests 6.0% is a reasonable prediction for one-year developed market equity returns for the foreseeable future.
“Valuations, while still elevated, actually retreated this past year as per-share earnings grew faster than equity prices,” the report states. “We don’t expect a tailwind from valuations during the next five years, but we don’t expect a material headwind either.”
Breaking down the 6.0% total return figure, the report projects 4.2% coming from revenue growth and a 2.4% dividend yield. Valuations “bring this back by 0.9%.”
Strong outlook for emerging markets
According to Northern Trust, moderate growth and lower valuations should benefit emerging market equities, which are expected to return 8.3% per annum.
“Emerging markets are notorious share issuers, and will see a negative 2.2% profit translation as a result,” the forecast report explains. “The 6.9% revenue growth we’re projecting, combined with a 1.1% boost from valuations and a 2.4% dividend yield, will allow for a 2.3% return premium over developed market equities.”
Tempered fixed-income forecast still positive
Northern Trust anticipates that long-term interest rates will remain anchored in place, meaning the current U.S. Federal Reserve rate hike cycle may end earlier and at a lower level than is priced into the markets currently.
“Also controlling short-term U.S. rates is the ongoing accommodation from other major central banks in response to low inflation,” the report explains. “The result will be a nearly flat U.S. yield curve and a very small shift upward in other yield curves around the world.”
The report further suggest that credit spreads, both investment grade and high yield, will settle at slightly higher levels than the lows seen during the current cycle.
Real assets and alternatives also look strong
According to Northern Trust, ongoing global economic growth and better calibration between supply and demand will allow recent outperformance of the natural resources asset class to continue. Global real estate, at the same time, will be supported by its exposure to interest rate and credit risk, both of which Northern Trust analysts expect to be positive influences on the asset class.
“Negative investor sentiment remains as the real estate market is forced to respond to the more digitally based economy,” the report warns. “These are issues we have flagged before, but they remain a drag on demand. As such, we continue to adjust downward our quantitatively driven return forecast.”
The forecast report concludes that global listed infrastructure assets “can serve as a lower risk, but also slightly lower return, alternative to global real estate for income generation.”
For the private equity asset class, Northern Trust foresees “more opportunities offsetting slightly higher valuations and increased investor interest,” resulting on net in a 2.0% possible premium for private equity over listed equities. Applied to the 6.0% global equity return forecast, this implies an 8.0% return forecast for private equity.
Additional findings are available here.
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