Morgan Stanley has some bad news for portfolio managers: The easy money has been made.
Chief Cross-Asset Strategist Andrew Sheets is warning asset managers that the efficient frontier -- the mix of stocks, bonds and other instruments that produces the best risk-adjusted return -- is about to collapse:
A period of unprecedented monetary stimulus in the wake of the global financial crisis helped spur "an unusually benign" trade-off between the risk a portfolio manager is willing to take and excess returns generated.
That is, returns have been higher for a given level of volatility than the previous 20-year average. What's more, notes Sheets, is that the slope of the 2010-2015 frontier shows that adding more volatile holdings (like stocks) was a better risk-reward proposition than the period from 1990 to 2009.
But Morgan Stanley's forecasts for returns across asset classes suggest this is all about to change. Investors should prepare for an era of below-average returns, in which moving into riskier holdings won't juice performance as much as it has in the recent past. On either side of the Atlantic, the 10-year return from a portfolio equally divided between stocks and bonds is not expected to break 4 percent:
"What is notable for 2016 is that, unlike past years, both our long- and short-term forecasts point to muted equity upside," writes Sheets.
Morgan Stanley expects the S&P 500 to hit 2,175 at the end of 2016, a forecast that sits squarely in between targets set by competing equity strategists at Bank of America Merrill Lynch (2,200) and Goldman Sachs (2,100).
However, Bank of America's call for compounded annual returns of 8 percent from U.S. stocks over the course of the next decade far exceeds Morgan Stanley's 10-year expected annual return of 5 percent.
"Having been positive on developed market equities in recent years, it is notable that all of our regional index targets now imply little upside for stocks in 2016," wrote strategists Jonathan Garner, Adam Parker, and Graham Secker. "Morgan Stanley’s economists forecast that global GDP growth will nudge slightly higher next year (to 3.3 percent from 3.1 percent in 2015), but our regional earnings forecasts suggest companies are having a tougher time turning modest economic growth into decent profit growth."
The paltry yield available from sovereign debt in advanced economies has helped foster the notion that "there is no alternative" (or TINA) besides stocks for investors who want to generate a decent return -- a view that finds some support in the 2010-2015 efficient frontier.