Capital Group has released a 20-year forecast that predicts a 7.2% annualized return for U.S. equities, 7.1% for non-U.S. developed equity markets and 9% for emerging markets.
The Los Angeles-based investment firm predicted intermediate-term U.S. Treasurys will yield a 3.4% return, and a 6.6% yield for U.S. high-yield..
Meanwhile, U.S. inflation should average out at 2.25%, even if the Federal Reserve is successful at returning annual inflation to its 2% target, the firm said.
“We’ve always been talking about long-term returns in our target-date space and disclosed the info to our target-date clients,” said Maddi Dessner, head of global asset class services. “But we’ve seen more success with more sophisticated clients over time, and they want to see not just the result but also the underlying market assumptions.”
The forecast is an improvement over where projected returns were last year, when Capital Group thought U.S. equities would be closer to 5.8%.
“After the 15% drawdown in the 60/40 last year, we think it’s a better time to be investing,” Dessner said.
Still, the purpose of the 20-year capital market assumptions is not to highlight individual years but to look at the markets overall, even if the assumptions are updated annually, she said.
“For us, because we’re in a position where we’re taking people early in their careers, saving for retirement, all the way through their saving journey into the retirement and into the spending journey, we have to think long term,” she said. “That’s two market cycles typically. Over that time frame, the markets tend to even out so you have a clearer picture.”
How other financial advisors might come to use Capital Group’s data has yet to be seen, as the more typical forecasting that is popular with financial advisors addresses much shorter timeframes, like GMO’s seven-year forecasts and Vanguard’s 10-year forecasts.
At Cincinnati-based Touchstone Investments, the active investment manager creates its own capital markets assumptions and checks against other providers, said Richard “Crit” Thomas, the firm's global market strategist.
“We look at seven- and 10-year forecasts,” he said, adding each of those timeframes captures different aspects of the market. “And even that’s not great. I’ve seen 10-year forecasts with holes so big you could drive a truck through.”
It’s for that reason that he said he would have to see what Capital Group is doing with its data before determining whether he’d consider adding a 20-year timeframe to his analysis.
“If they can demonstrate that the 20-year timeframe is more appropriate because they have data that is more predictive over a 20-year timeframe than a 10-year timeframe, then they might have something,” Thomas said.
Forecasting longer-term returns—which requires integrating expected returns, correlations and volatility—is very difficult, he said.
“All three are difficult to pin down and then they change over time,” he said. “You just need one of those to be off to throw a big cog in the wheel.”
But Dessner said Capital Group’s 20-year forecast is appropriate for their products and their investors. “We have 20-year assumptions only, plus a 50-year internally.”
Capital Group uses a building-block methodology to develop its equities assumptions, she said, starting with real GDP growth plus inflation as the proxy for earnings growth. To this, the firm applies “additives,” which can be either positive or negative values. The additives for equities are share dilution/accretion, dividend yield, valuation impact and currency impact.
For fixed income, the building blocks start with yield to worst, to which the following additives are applied: valuation impact, default impact and currency impact.
“The future may not look like the past in certain ways. For example, we think the credit quality in the high-yield space will improve in the future, and we think spreads can get even more narrow than today, because high-yield bond quality will be getting higher and higher,” she said. “It’s not just mean reversion. It’s what do we think fair value is, and that may be different in the future.”
As for take-aways for Capital Group’s fans, Dessner said there are two: investors should not give up on the 60/40 as being a good starting point, and the weakening dollar over time will be a boon for investors holding international equities.