The TEXPERS Blog

Four key forecasts for stocks and bonds

By Matt Peron and Colin Robertson

Guest Columnists

Consider taking a global approach to investing, as emerging markets and Europe should present interesting opportunities. While global yields should remain low, relatively attractive yields can be found in the United States fixed income market.

Here are just some of our forecasts for the next five years:

Emerging Markets Should Outperform

Investors may want to keep emerging markets in mind, as they represent attractive opportunities for stocks and bonds. We expect emerging markets to return 8.4 percent for equities and 5.3 percent for bonds, exceeding developed markets. Emerging market performance may reflect relatively strong economic growth and increasing demand from within their home markets. Valuations should increase, as they are too low for the stable economic environment we expect.

Look for U.S. Yields to Lead

We think the U.S. should continue to have the highest rates across the yield curve of all major economies with a 3 percent yield for 10-year Treasurys. Outside the U.S., we expect other countries’ rates to move out of negative territory, although Japan may remain close to 0 percent.

Investors may find that higher government yields will translate into higher yields across the U.S. fixed income market. We think returns from U.S. investment-grade bonds should lead globally, at a 3.2 percent return.

Still, global yields are low versus historical averages, reflecting low inflation and cautious central banks. Although central banks should begin the process of reducing the size of their balance sheets, we believe this should occur at a very slow, gradual and transparent pace and be unlikely to cause market volatility.

U.S. Equities to Lag Other Developed Markets

Keep a global perspective. Beyond just the opportunities in emerging markets discussed above, Europe and Asia may present more opportunities for investors than they have in the past. Globally, developed market equities are in a sweet spot of steady growth and low inflation. However, when breaking down regional contributions, we see a 5.9 percent return in the U.S., trailing other developed markets (see Exhibit 1 below). We think profit margins in the U.S. should fall slightly but remain high in Europe and Japan. We are encouraged by European regulatory developments, which we expect will boost economic growth and financial markets.

High-Yield Defaults Should Fall

In the high-yield market, investors are unlikely to benefit from a contraction in credit spreads. The global high-yield market looks much different than it did a year ago, when volatile oil prices threatened energy companies. Since then, defaults have slowed and credit spreads have narrowed to more normal levels.

We don’t think there is as much opportunity for spreads to narrow further. We see a 4.5% return for global high yield, 1% lower from current yields. This represents a lower hit from defaults than we have realized historically in the past.

Stay Fully Invested and Well Diversified

While steady global growth provides a bedrock for investing in the coming years, this is not a high-performance investing environment. We expect traditional stock and bond portfolios to return 4 percent to 6 percent. Cash returns are very low, so investors who are not fully invested are penalized even further by taking money out of the market. We think that investors should stay fully invested with a diversified portfolio throughout market cycles for the best chance to reach their portfolio goals.

The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of Northern Trust or TEXPERS.