In Search Of Higher Returns

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Includes: ADRE, BIK, BKF, BNO, DBEM, DBO, DIA, DNO, DTO, DWTI, EDBI, EDC, EDZ, EEB, EEM, EEME, EET, EEV, EMCR, EMDD, EMF, EMFT, EMLB, EMSA, EUM, EWEM, FEM, FXY, GMM, HEEM, IEMG, JYN, KEMP, KLEM, LLEM, MSF, OIL, OLEM, OLO, QQQ, SCHE, SCO, SPY, SZO, UCO, UDN, USDU, USL, USO, UUP, UWTI, VWO, XSOE, YCL, YCS
by: Richard Turnill

Summary

We have lowered our five-year return expectations, particularly for fixed income assets, in our latest quarterly assumptions.

Risk assets rallied last week, led by emerging market stocks. Crude oil prices hit a 2016 high on hopes of output cuts.

We see a supportive economic backdrop for stocks. The U.S. dollar could be less of a headwind to U.S. earnings later this year.

This week we updated our capital market assumptions for returns over the next five years. We see lower returns ahead, given moderate economic growth and stretched valuations.

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The bars in the chart above show our return assumptions for selected asset classes, while the dots show expected volatility. Higher returns generally come with more volatility. Many of our return assumptions are now at or near post-crisis lows, with many expected returns below historical averages. These assumptions reflect high current valuations and lower global growth over the next five years, in line with a long, flat U.S. recovery.

No free lunch

We see a global portfolio made up of 60% equities and 40% fixed income producing annual returns of just 3.3% in U.S. dollars, before inflation, over the next five years. Generating returns is likely to be particularly challenging for investors in U.S. assets. We estimate annual returns of less than 3% for a 60/40 U.S. portfolio, and less than 1% after inflation.

Negative returns may also be more widespread, given that many benchmark rates hover around 0%. We now anticipate negative returns over the next five years from assets such as long-dated Treasuries and eurozone bonds. These assets are still important portfolio diversifiers, but the price of that diversification is rising.

We see a wider gap between the prospective returns for safe-haven and risk assets, reflected in higher expected returns for equities versus bonds and for non-U.S. equities versus U.S. equities. Our international equity return estimates are now above the long-term average, thanks to improved valuations outside the U.S.

Alternatives come with higher volatility and illiquidity, but we believe real assets can offer portfolio diversification benefits. The bottom line: Generating higher returns over the longer term involves accepting more volatility or illiquidity risk, or focusing on assets with higher return potential.

  • Risk assets rallied, led by EM equities. A weaker yen boosted Japanese stocks. The MSCI World Index entered positive territory for the year.
  • Sentiment improved on positive Chinese trade data and a decent start to the first-quarter U.S. earnings season. Materials sector earnings are seeing upward revisions for the first time in two years.
  • Crude oil prices hit a 2016 high, ahead of the April 17 OPEC meeting.

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This post originally appeared on the BlackRock Blog.