The U.S. economy will strengthen, and inflation will remain low in 2015, keeping yields and returns of fixed-income investments relatively modest, Wilmington Trust analysts said.
Emerging markets should also prosper, particularly relative to developed ones, the trust company said in its latest Capital Markets Forecast.
“The U.S. has reemerged as the dominant global economic powerhouse, and we believe that will increasingly be the case, at least for the first half of our seven-year forecast time horizon,” Wilmington Trust Chief Investment Officer Tony Roth said in a conference call last week.
U.S. GDP growth continues to gain traction on the strength of exports and government spending, and Wilmington Trust expects this to continue over the forecast period. Consumer spending and confidence are likely to keep rising, the analysts said.
“If we look back, the longest economic cycle we’ve seen has been 10 years—the longest without a recession,” Roth said. “We think that we could have a period here that is a longer recovery than we’ve seen in the past.”
He acknowledged, however, that the U.S. economy faces persistent challenges, such as slack job market and sluggish housing market.
As well, he said, with a stronger U.S. economy comes a stronger dollar, which is likely to continue to appreciate against other developed markets. On the one hand, this will bring increased capital flows into the U.S., boding well for domestic stock prices. On the other hand, it will likely result in higher prices abroad for U.S. goods and services, meaning investors should anticipate some combination of lower exports or a lower dollar in the latter half of the forecast period, Roth said.
Normalized Environment
The forecast predicts inflation will average 1.9 percent across the seven-year horizon, with higher rates toward the end of the period. In the shorter term, inflation will be compressed, given that workers are likely to have little pricing power and residual global slack weighs on prices.
Considering that interest rates may rise this year, probably around the middle of the year, Roth said, “We view that as a move by the government toward a more normalized environment. We do not view that as a move that is in any way, shape or form driven by the need on the part of the government to keep rates in check as a result of inflation. That’s a very important distinction.”
Although bond yields moved lower during 2014, Wilmington Trust forecasts a rise in yield levels in the years ahead. It anticipates that nominal yields for 10-year government bonds will peak at 3.5 percent during the next seven years, while real returns could range from near zero to negative, both domestically and internationally.
Return prospects for investment-grade and high yield corporate bonds should be higher than government securities, in a range from 3 percent to 6 percent annually—still quite low on a historical basis. Performance for international developed market debt will likely be even lower.
Wilmington Trust continues to favor equities with the expectation that its level of commitment will only modestly exceed market weights. The 2015 forecast predicts mid-single-digit stock returns, more than it forecasts for bonds for the next few years.
No Longer Homogenous
The report expects a convergence between developed and emerging markets during the forecast period, even as a divergence exists between the U.S. and most other developed international markets. Emerging economies will likely emulate economic policies that have worked well in developed markets, and should experience generally solid income, productivity and economic growth, presenting an area of opportunity.
Wilmington Trust projects emerging market nominal growth rates of 6.5 percent on average between 2014 and 2019, compared with 4.4 percent for developed economies. Emerging economies’ global share of GDP is expected to rise to 42 percent and that of development markets to fall to 58 percent.
The forecast predicts that emerging markets won’t keep pace with their growth rate of the last 15 years. However, these economies continue to need basics, so they are expected to sustain higher growth rates than developed economies. Mexico, South Korea and Southeast Asia should come to the forefront of emerging economies in the near term, according to the forecast.
Roth said Wilmington Trust has been pointing out to its clients that emerging markets can no longer be viewed as a monolithic bloc. “These economies increasingly diverge from one another, and some countries are in much later stages of the development cycle—China, for example.”
Others, such as Brazil, are experiencing significant stalling as a result of their connection to commodities, he said. “We’re seeing much smaller economies in the emerging space that are at an earlier stage of their development cycle that represent interesting investment opportunities over the forecast timeline.”