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Strategies to Beat a Leaner Long Term

20 December 2016
The easy money policies that lifted the world out of the global financial crisis borrowed from the future. Now that future has arrived. Thats the message from J.P. Morgan Asset Managements latest edition of its Long-Term Capital Markets Assumptions. The surprise U.S. election result may have shaken up the short term, but our Assumptions look beyond current events and consider the outlook over a 10- to 15-year horizon.

Every year for the past 21 years, the firm has put out an exhaustive long-term projection of the performance of the global economy and returns for major asset classes. In this years edition, based on market data as of September 30, our macro economists and investment strategists anticipate that the structural challenges of aging populations, together with below-average productivity, will constrain real economic growth, with estimates for developed market growth over the next 10- to 15-years cut by 25 basis points (bps) to 1.50% and emerging market growth cut by 50bps to 4.50%.

Letting go of 60/40

Lower growth translates to lower equilibrium interest rates and a very slow path of policy normalization. Meanwhile, the years of quantitative easing around the world have pushed bond yields to an extraordinarily low level even after their recent rise. Combined with muted stocks performance, our annual return outlook for a simple balanced 60/40 stock-bond portfolio falls by around 75bps, reinforcing our view that static balanced allocations have run out of road.
Investors face a stark choice: Accept a lower level of return and stay static, or explore alternative assets more fully, seek new sources of diversification and embrace an active allocation approach.



Fixed income: laggardsand leadersin the trudge to normalization

Fixed income interest rates will rise, though not to pre-crisis levels, according to the J.P. Morgan forecast. That will inevitably squeeze fixed income. In fact, given the absence of a duration premium in todays market pricing, the return from government bonds may not be much better than holding cash.
There are, however, bright spots within fixed income, and credit in general offers reasonable longer-term returns to investors. The credit risk associated with corporate bonds is, by and large, well reflected in todays spreads. The outlook for longer maturity investment grade credit as well as high yield debt is closer to pre-crisis norms than that for government bonds. Emerging market debt also offers investors some opportunities, and while recent events have introduced some near term uncertainty into emerging markets, the higher rate of growth over the longer term underpins the prospects for EM debt.

Equities: buybacks will keep the pot simmering but not bubbling

Weve reduced our expectations for global equity markets roughly in line with cuts to our macro growth estimates and taking into account that starting point for world equity valuations has risen compared with last year. Our total return forecasts range from the mid to high single digits across all major equity regions. In contrast to the emerging market outlook, where we think EPS growth will drive equity returns, we believe a large portion as much as two thirds of developed market equity returns will come from yield in a combination of dividend payouts and share buybacks.

Investment implications

In our long-term view, investors will increasingly have to consider alternative assets, new avenues of diversification and, above all, an active approach to asset allocation. The current edition of J.P. Morgans Long-Term Capital Markets Assumptions points to several strategies that could for a 10- to 15-year investment horizon:

Credit remains the bright spot in fixed income, given the modest growth environment we are projecting.

Emerging economies are projected to grow at a faster pace than developed markets over the next 10 to 15 years and this should translate to a reasonable outlook for both emerging market equity and debt.

Real estate holds potential with a combination of appealing valuations and strong operating income.

Learn more about our 2017 Long-Term Capital Market Assumptions here.

The original article Strategies to Beat a Leaner Long Term




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