Of all the challenges facing investors in this blighted year, maintaining a long-term perspective may be the hardest. In recent weeks, markets have swayed back and forth in reaction to case counts, vote counts, vaccine news and stimulus views, obscuring longer-term trends on economic growth, inflation, earnings and interest rates. It has also been tempting to ignore the crucial importance of current valuations in driving long-term returns or to underestimate the potential for recently unloved assets to reduce current portfolio volatility and enhance long-term returns.
Given all of this, it is particularly timely that last week we released the 2021 edition of our Long-Term Capital Market Assumptions. This project, now in its 25th year, draws from experts across JPMorgan Asset Management in developing investment themes, economic forecasts and return and correlation projections across all major markets and asset classes for the next 10 to 15 years.
Among the key themes this year:
• Despite the pandemic, the long-term paths of slow growth and low inflation remain intact, albeit with greater uncertainty around inflation.
• The pandemic has triggered even easier monetary policy. However, fiscal policy is likely to take the leading role in promoting economic growth in the decade ahead.
• Strong returns from equities and high-quality bonds through the pandemic have left valuations stretched. A traditional 60/40 portfolio of global stocks and U.S. bonds presents a very subdued frontier of potential returns.
• However, many other asset classes shine above this low horizon, including international equities, high-yield and emerging market debt and an assortment of alternative investments. In addition, active management should be able to take advantage of distortions in relative valuations that have been created by years of central bank intervention and momentum investing.
Digging a little deeper, it may seem surprising that growth forecasts have not been much altered by the very deep recession triggered by the pandemic, since the obvious assumption is that a weak starting point should imply a faster long-term growth rate. However, it’s important to note that our forecast period began on October 1st, 2020 rather than earlier in the year. While global real GDP fell 8.1% (in non-annualized terms) between the fourth quarter of 2019 and the second quarter of 2020, a very strong surge in the third quarter cut the decline to just 0.5%, leaving a much smaller output gap to be closed.
As the pandemic ends, the global economy should move back towards full employment fairly rapidly, since most of the current economic weakness is centered in sectors where there is both pent-up demand and pent-up supply, ready to be unleashed once we are given the medical all clear. However, progress thereafter will be slow.
In the developed world, weak demographics should result in employment growth of just 0.6% per year in the U.S. and negative growth in Japan and the European Union. These trends will only partly be offset by moderate growth in the capital stock and advances in the efficiency with which capital is deployed. Labor supply and productivity growth should be stronger in emerging markets. Still, over the next 10 to 15 years, we are looking for average real GDP growth of just 1.8% in the U.S., 1.6% in developed countries overall and 3.9% in emerging market economies. These forecasts are unchanged from a year ago for the U.S. and emerging markets and just 0.1% higher than last year’s for developed countries in general.
On inflation, the pandemic has opened up an output gap that could reduce inflation as could the earlier adoption of some laborsaving technologies. Conversely, a greater emphasis on fiscal stimulus and potential government actions to reduce inequality and to battle climate change could add to inflation. While all of these pressures are extremely difficult to estimate in advance, we are willing to assume that they could be roughly offsetting, leaving us with a forecast of 2.0% CPI inflation in the U.S., 1.6% in developed economies overall and 3.3% across emerging markets, all unchanged from last year. It should be emphasized, however, that the effects of the pandemic economy in accelerating technological change and a more aggressive use of fiscal stimulus going forward have added to inflation tail risks in our forecast.