Global economic expansion should continue at a slow, steady pace over the next five years, with interest rates rising only gradually and stocks returning 7 to 9% per year over the period, according to Northern Trust’s annual long-term forecast for the economy and capital markets.
long with "Enduring and Maturing Global Growth," key themes of the five-year outlook include a continuing search for yield and a new era of heightened geopolitical risk counterbalanced by the increased globalization of financial markets.
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"The sub-par growth trajectory since the 2008 global financial crisis has prevented excesses in developed market real economies and required central banks to continue monetary policies that have supported equity market valuations," Northern Trust Chief Investment Strategist Jim McDonald said.
"Meanwhile, emerging markets continue to adjust to a maturing growth profile, which weighs on global growth but also reduces inflationary pressures. Effectively, the mediocrity of the current expansion increases its expected longevity."
Each year, Northern Trust’s Capital Market Assumptions Working Group, composed of senior investment professionals from across the global organization, develops a long-term forecast for economic activity and financial market returns that is designed to be "forward looking and historically aware."
The group also identifies specific risks that are combined with other portfolio construction tools to annually review and update the firm’s recommended strategic asset allocations.
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By GlobalDataFor investors, the macro environment will produce slightly lower equity returns and slightly higher fixed income returns over the next five years, according to the report:
The forecast for developed market equities has fallen to reflect the expansion in valuations over the previous 12 months; though both margins and valuations are expected to remain above longer-term averages, leading to annualized returns of 7.2 percent.
Emerging market equities will command a premium, with annualized returns of 9 percent, however maturation reduces growth prospects.
Fixed income returns will rise slightly for longer-dated bonds, as the markets price in higher long-term interest rates. Northern Trust’s forecasts for short-term rates set by central banks are lower than the market consensus. The continuing search for yield and low default rates will favor credit investments.
Real assets provide protection against unanticipated inflation; global real estate and global listed infrastructure are the strongest asset classes.
Private equity and hedge funds also play important roles in investor portfolios, with the potential to outperform public equities and provide diversified exposure, but manager selection is critical.
"The robust returns of recent years have reduced the valuation cushion in asset markets, but while nominal returns will likely lag historic averages, we see real returns of 4 to 5 percent for global stocks and 1 to 2 percent for global fixed income over the period," McDonald said.
"This means that bonds can continue to serve as an important diversifier and source of liquidity while equities and alternative investments provide capital appreciation potential."
In addition to asset class forecasts, the five-year outlook considers key risks and themes to guide investors. For example, the theme "Geopolitical Risk: A Balanced Assessment" notes that recent conflicts have the potential to reintroduce a Cold War-style geopolitical variable and turn back globalization initiatives.
However, as conflicts are increasingly handled through the financial system – cutting off credit or taking other measure as opposed to military intervention – the risk of geopolitical escalation is reduced. It could also serve as an economic catalyst, such as potential demand from increased military spending and new energy infrastructure build out.
Other themes in the report include "Emerging Markets: Becoming More Value than Growth," which finds these markets transitioning from a homogeneous high-growth cohort; "The Search for Yield," which predicts the low-rate environment will maintain demand for yield-producing investments, including fixed income and alternative strategies; and "Asset Classes Without Borders," in which asset allocation will focus less on where companies are domiciled and more on where they generates revenues.
