Returns In A Reflationary Environment

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Key points

  • Our updated five-year return outlook supports our preference for equities over bonds in a U.S.-led reflationary environment.
  • Global risk assets rallied last week, led by emerging markets. U.S. equity indexes hit record highs on upbeat earnings.
  • Ratios of earnings upgrades to downgrades in Europe and Japan offer encouraging signs ahead of this week's earnings reports.

We have updated our five-year return assumptions across asset classes to reflect strengthening reflation and changing markets over the last quarter. We have largely maintained our assumptions for equity returns while increasing those for fixed income.

BlackRock's five-year asset class return assumptions, January 2017

Sources: BlackRock Investment Institute and BlackRock Solutions, January 2017.
Notes: This information is not intended as a recommendation to invest in any particular asset class or strategy or as a promise of future performance. The bars show annualized nominal return assumptions for the next five years from a U.S. dollar perspective. Representative indexes used are (left to right): Bloomberg Barclays Global Aggregate Treasury Index ex U.S., Citigroup 3-Month Treasury Bill Index, Bloomberg Barclays Government Index, Bloomberg Barclays U.S. Government Inflation-Linked Bond Index, Bloomberg Barclays U.S. Credit Index, Bloomberg Barclays U.S. High Yield Index, JP Morgan EMBI Global Diversified Index, MSCI USA Index, MSCI USA Small Cap Index, MSCI World ex USA Index and MSCI Emerging Markets Index. Indexes are unmanaged and used for illustrative purposes only. They are not intended to be indicative of any fund or strategy's performance. It is not possible to invest directly in an index.

Our stock return assumptions remain at historically low levels, despite broad gains in equity indexes. We see support from economic reflation and earnings growth. A rise in global yields has made bond valuations less rich, leading to our higher bond return expectations, especially for government and emerging market (EM) debt.

A preference for stocks over bonds

Overall, we now see a global portfolio consisting of 60% equities and 40% bonds generating a nominal annual return of 3.9% in U.S. dollar terms over the next five years before fees. This is up from last quarter but still implies very low real (after-inflation) returns.

We have greater confidence that inflation will meet central bank targets, with some scope for overshooting in the near term as economies are allowed to run a little hotter. We see U.S.-led reflation taking root globally and have nudged up our five-year inflation expectations for the U.S. and UK. We have left our five-year economic growth forecasts unchanged for now awaiting further evidence, but we believe the upside risk to these assumptions has increased. At the same time, structural factors such as aging societies, weak productivity and excess global savings should ensure bond yields rise at only a gradual pace in the years ahead, we believe.

We prefer equities over fixed income in this reflationary, low-yield and low-return environment, and favor credit over government bonds. We believe investors are compensated for taking risk, especially in non-U.S. equities, selected credit and less liquid assets. Bottom line: Expected stock returns appear relatively attractive in a world of low returns.

  • Global risk assets rallied, led by EMs. U.S. equity indexes hit new highs. The yield spread between EM debt and U.S. Treasuries fell back to pre-U.S.-election levels. Japanese exports rose.
  • Financials and tech led upbeat U.S. earnings. Italy may join France and Germany in having elections this year after its constitutional court approved a new electoral law.
  • During his first week as president, Donald Trump formally withdrew the U.S. from the Trans-Pacific Partnership and vowed to renegotiate the North American Free Trade Agreement.

Global snapshot

Weekly and 12-month performance of selected assets

Equities Week YTD 12 Months Div. Yield
U.S. Large Caps 1.0% 2.5% 21.9% 2.1%
U.S. Small Caps 1.4% 1.0% 38.8% 1.5%
Non-U.S. World 1.6% 4.1% 18.2% 3.1%
Non-U.S. Developed 1.3% 3.4% 13.1% 3.3%
Japan 1.1% 3.5% 15.7% 2.0%
Emerging 2.5% 6.2% 31.0% 2.7%
Asia ex-Japan 2.4% 6.6% 25.2% 2.6%

Bonds Week YTD 12 Months Yield
U.S. Treasuries 0.0% 0.1% -0.6% 2.5%
U.S. TIPS 0.2% 0.8% 4.6% 2.2%
U.S. Investment Grade 0.1% 0.2% 6.3% 3.4%
U.S. High Yield 0.4% 1.5% 21.6% 5.8%
U.S. Municipals -0.1% 0.5% -0.3% 2.6%
Non-U.S. Developed 0.2% 0.6% 1.4% 0.8%
Emerging Market $ Bonds 0.2% 1.4% 12.6% 5.7%

Commodities Week YTD 12 Months Level
Brent Crude Oil 0.1% -2.3% 67.7% $55.52
Gold -1.6% 3.8% 5.9% $1,191
Copper 2.6% 6.6% 28.5% $5,899

Currencies Week YTD 12 Months Level
Euro/USD 0.0% 1.7% -1.8% 1.07
USD/Yen 0.4% -1.6% -3.0% 115.10
Pound/USD 1.5% 1.7% -11.8% 1.26

Source: Bloomberg. As of January 27, 2017. Notes: Weekly data through Thursday. Equity and bond performance are measured in total index returns in U.S. dollars. U.S. large caps are represented by the S&P 500 Index; U.S. small caps are represented by the Russell 2000 Index; Non-U.S. world equity by the MSCI ACWI ex U.S.; non-U.S. developed equity by the MSCI EAFE Index; Japan, Emerging and Asia ex-Japan by their respective MSCI Indexes; U.S. Treasuries by the Bloomberg Barclays U.S. Treasury Index; U.S. TIPS by the U.S. Treasury Inflation Notes Total Return Index; U.S. investment grade by the Bloomberg Barclays U.S. Corporate Index; U.S. high yield by the Bloomberg Barclays U.S. Corporate High Yield 2% Issuer Capped Index; U.S. municipals by the Bloomberg Barclays Municipal Bond Index; non-U.S. developed bonds by the Bloomberg Barclays Global Aggregate ex USD; and emerging market $ bonds by the JP Morgan EMBI Global Diversified Index. Brent crude oil prices are in U.S. dollars per barrel, gold prices are in U.S. dollar per troy ounce and copper prices are in U.S. dollar per metric ton. The Euro/USD level is represented by U.S. dollar per euro, USD/JPY by yen per U.S. dollar and Pound/USD by U.S. dollar per pound. Index performance is shown for illustrative purposes only. It is not possible to invest directly in an index. Past performance is not indicative of future results.

Asset class views

Views from a U.S. dollar perspective over a three-month horizon

This post originally appeared on the BlackRock Blog.

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