The writer is head of global multi-asset strategy at JPMorgan Asset Management
By any measure, it’s been an ugly year for investors. Stocks and bonds tumbled in tandem — a rare phenomenon. The mainstay of the investing world, the 60/40 portfolio, suffered a brutal setback, down 19 per cent year-to-date. That ranks as the worst drawdown since the global financial crisis in 2008.
But look past those losses and the long-term strategy that allocates 60 per cent to equities and 40 per cent to fixed income and was declared extinct by some commentators, is poised for a comeback.
The investing landscape is shifting. We’re moving from a world of low inflation and easy financial conditions to one with two-way inflation risk, tightening policy and higher rates. That will create fresh opportunities — along with new risks to manage.
Specifically, we expect a much greater range in returns across asset classes. Investors can reap the benefits, or suffer the fallout, of shifts in inflation and policy. And even as public stock and bond markets offer much-improved potential returns, alternative assets offer an attractive combination of manager skill, inflation protection and diversification.
Some powerful forces brought us here. Most important, unprecedented easy monetary policy — many years of negative policy rates and large central bank balance sheets — suddenly reversed. Very few asset classes emerged unscathed in the bear market of 2022.
Investors can view the past year’s volatility as bringing market pricing “back to par”. The reversal of cyclical elements of asset returns, like starting yields and valuations, swung from headwinds to tailwinds.
On the macroeconomic outlook, the trajectory for trend global growth over the next decade is little changed, at 2.2 per cent. Our forecast for global inflation over the next 10 years increases only modestly, to 2.6 per cent. Despite near-term economic risks, we expect the imbalances behind today’s inflation spike to moderate in the next year. And over the coming decade, the longer-term disinflationary forces of technology adoption and globalisation may slow, but they won’t disappear.
With that supportive backdrop, our projected returns rise substantially for both components of the 60/40.
Our annual Long-Term Capital Market Assumptions forecast return for a dollar-denominated 60/40 stock-bond portfolio over the next 10 years leaps from 4.3 per cent last year to 7.2 per cent. Although volatility almost certainly lies ahead, it’s the highest projected return since 2010 and well above the rolling 10-year annualised realised average of 6.1 per cent.
With higher yields, bonds are once again a plausible source of income and a potential haven. And at lower valuations, equities are more attractive. The combination of the two means that markets today offer the best potential long-term returns in more than a decade.
First, the “40” — the ballast of the portfolio. After policy rates normalised swiftly, real return forecasts for most sovereign bonds moved back into positive territory. For the first time since the global financial crisis, prevailing interest rates in most currencies have settled at or above the “cycle-neutral” rate — the rate that prevails on average over the long-term. This implies that the normalisation of rates no longer acts as a drag on returns in most markets.
The impact is minimal in cash but meaningful for longer-duration bonds. For US 10-year bonds, the cycle-neutral yield rises 0.2 percentage points, to 3.20 per cent in our forecast. Much higher starting yields push our return forecast up by 1.6 percentage points, to 4 per cent. The outlook for credit improves as well. Credit losses in 2022 mainly reflect the jump in government bond yields. Spreads widened moderately, but light supply, solid corporate balance sheets and a limited need for refinancing meant credit spreads outperformed equities.
In the “60” share, our projected equity returns rise sharply. The developed market equity forecast jumps 3.6 percentage points, to 8.40 per cent (in dollars), and the emerging market equity forecast increases 3.2 percentage points, to 10.10 per cent.
A year ago, global equities were expensive. Today, they are considerably cheaper but, crucially, the underlying businesses are largely in good shape. Valuations are now close to, or in some cases below, our estimates of fair value. Corporate profit margins look high, a potential headwind to near-term returns. But we think profitability will prove resilient over the long term.
Yes, this year has been painful. But looking ahead, we see the best environment in a decade for asset class returns — inviting investors to refocus on long-term portfolio goals within the revitalised 60/40 framework.