While an extraordinary year has had remarkably little impact on our growth and inflation forecasts, it has changed the policy landscape in a profound way. In the last decade, monetary policy was the primary tool deployed by governments around the world to stimulate economic growth and foster higher inflation. However, its relative failure to achieve these objectives, which we discussed in last year’s Long-Term Capital Market Assumptions, has led to a greater acceptance of the use of fiscal stimulus. This has accelerated dramatically in the pandemic, as governments have expanded deficits to meet higher medical expenses and protect laid-off workers and shuttered businesses. Importantly, central banks have been co-opted into this effort and massive increases in government debt have been matched by almost equally massive increases in central bank government bond holdings.
This expansion in deficits will likely continue to shape the economic environment for years after the end of the pandemic. Nevertheless, there are limits, however ill defined, to how much governments can borrow to finance deficits or how effectively they can deploy fiscal stimulus. We investigate this on a country-by-country basis in this year’s Long-Term Capital Market Assumptions.
A second significant change in our long-term outlook derives from the pricing of assets themselves. In the year that ended September 30, 2020, even as earnings cratered in reaction to the pandemic, the S&P500 rose by 13% and the MSCI World Index in U.S. dollar terms rose by 8.6%.
Even spaced out over 10 to 15 years, these higher prices today cut into future returns, which we now project at 4.1%, 6.5% and 7.2%, in U.S. dollar terms, for the S&P500, the MSCI EAFE and the MSCI EM, compared to 5.6%, 7.2% and 9.2%, respectively, a year ago.
A similar pattern shows up in fixed income markets where rates are significantly lower than a year ago. Given very low starting yields and a slower pace of normalization, we now expect average returns from 1.1% from U.S. cash, 1.6% from U.S. 10-year Treasury bonds and 2.5% from U.S. investment grade corporate bonds, a further downgrade from projections of 1.9%, 2.4% and 3.4%, respectively, a year ago.
Because of this, a plain vanilla 60/40 portfolio of global equities and U.S. bonds is now projected to provide an annual return of just 4.2% over the next 10 to 15 years compared to 5.4% a year ago. It is important for investors to take this on board when considering their long-term financial plans.
However, it is also important to recognize that a number of assets appear to have the potential to outperform this average. In particular, we expect international equities in general to exceed these returns, bolstered by a roughly 1% annualized decline in the U.S. dollar. High-yield bonds and emerging market debt should significantly outperform developed country government debt. In addition, alternative investments, such as private equity, core real estate and global infrastructure should be able to provide strong income flow, diversification benefits and, with skilled management, some superior performance.
Our 2021 Long-Term Capital Market Assumptions don’t paint a particularly rosy picture for long-term investors but we believe it is a balanced and useful one. More importantly, these long-term projections are not a landscape to be contemplated in complacency or dismay but rather a roadmap to be consulted with purpose. As the confusion from this year clears, it is important for investors to refocus on the long run, to acknowledge what has changed and to adjust portfolios accordingly to achieve their long-term investment goals.
David Kelly is chief global strategist at JPMorgan Funds.