Selectivity Will Remain Critical
On an inflation-adjusted basis, the 10-year cumulative average annual return for stocks is 12.4%, which is quite high relative to a longer history and is almost certainly unsustainable.4Over the long-term, we think secular factors such as a rise in populism and protectionism around the world, the likelihood of higher tax rates in the U.S., rising debt and deficit levels, an eventual uptick in inflation and higher equity valuations will all conspire to keep stock returns relatively low.
These same factors are also going to hurt returns on other asset classes, chiefly areas of the bond market. Since the early 1980s, long-term inflation has been falling, providing a secular tailwind for the bond market. But inflation now appears to be bottoming, which spells trouble for fixed income markets. We expect stocks will outperform bonds over the coming years, but that will provide little solace for equity investors if their returns are limited as well.
This means that investors should focus on selectivity, be nimble and flexible and rely on diligent research to uncover opportunities. In particular, we think it makes sense to focus on areas of the equity market that have not yet fully priced in the effects of the current and pending global economic recovery. In particular, cyclical areas of the market look more attractive than defensive ones. From a sector perspective, we favor technology and health care and expect the relative cheapness and reasonable quality of the financial sector could also make that area of the market attractive. Additionally, we expect non-U.S. stocks to start outperforming on a relative basis later this year, especially if we see continued weakness in the U.S. dollar.
Robert C. Doll is senior portfolio manager and chief equity strategist at Nuveen.
1 Source: Federal Reserve
2 Source: Bureau of Labor Statistics
3 Source: Bloomberg, Morningstar and FactSet
4 Source: Bank Credit Analyst