5 Year Return Forecasts

COVID-19 Challenges Investment Portfolios

By DANIEL PHILLIPS/Guest Contributor

In recent years, global equities had slightly outpaced market forecasts for lower equity returns. Then the COVID-19 pandemic hit the global economy, putting an end to the 10-year bull market. Equity markets have now started to recover, but the pandemic introduced and exacerbated challenges that we expect to subdue financial market returns over the next five years. Here are our five-year annualized return forecasts.

FIXED INCOME 

• Global investment grade: 1.6%
• U.S. investment grade: 2.3%
• European investment grade: 1.0%
• U.S. high yield: 5.5%

Bond returns are based on our interest rate and credit spread expectations. Slower growth and central bank desire for (but not a realization of) higher inflation will keep short-end rates anchored at zero or below. As short-end rates stay low and inflationary problems don’t materialize, we expect longer-end rates to fall short of five-year market expectations — most notably in the U.S. and Japan.

Credit spreads should continue to slowly contract from the pandemic-induced spike with support from central banks. Spreads will stay higher than pre-pandemic levels as the new search for yield (pushing spreads down) meets the economic pressures (keeping spreads elevated). High-yield spreads will be attractive but overall yields will not go below an absolute level, limiting spread tightening.

EQUITIES

• Developed markets: 4.8%
• Emerging markets: 5.4%
• U.S.: 4.7%
• Europe ex U.K.: 5.4%

We expect developed market equity returns to range from 3.8% (Japan) to 5.8% (Australia) — all below historical averages. We have shaved our revenue forecasts in all non-U.S. developed markets, which are less able to capture economic growth given less competitive companies losing market share to U.S. companies.

We see lower global valuations driven by U.S. equities, where we believe valuations are elevated beyond even what should be expected in the current low-rate environment. In other regions, we expect some increase in currently cheap valuations versus historical averages. Expected dividend yields are largely unchanged, as most pandemic-related cuts have already occurred.

REAL ASSETS

• Global natural resources: 3.6%
• Global listed real estate: 6.3%
• Global listed infrastructure: 5.8%

With natural resources, slow economic growth will continue to pressure the supply/demand balance of commodity prices, notably in the energy sector. Meanwhile, climate risk also represents a headwind.

Term and credit risk exposures should be supportive for global real estate given our lower-for-longer interest rate expectations. However, this support will likely be offset by permanent impairment of many property types, notably retail and office spaces that are likely to be in lower demand because of the pandemic.

Listed infrastructure’s term exposure, yields and historical downside protection should make it attractive in the economic and market environment we expect. Pandemic implications — for instance, lost revenue for airports, pipelines and rail/toll roads — take some shine off the asset class but should not be permanent headwinds.

THE PORTFOLIO FORECAST

All-in-all, our five-year forecasts call for a 3.9 % annualized return for a portfolio invested 60% in global equities and 40% in U.S. investment-grade bonds, versus a realized 6.2 % annual return over the past five years. It’s enough to beat out stubbornly low inflation, but it represents a moderate return outlook after a decade of much stronger returns.

Download our full five-year outlook research paper that includes all of our forecasts and the global trends that support them.

Northern Trust is an Associate Advisor member of TEXPERS. The views expressed in this article are those of the authors and not necessarily Northern Trust nor TEXPERS.

About the Author: Daniel J. Phillips is the director of asset allocation strategy for Northern Trust Asset Management. He is also an Investment Policy Committee member, and portfolio manager for Northern Trust's Global Tactical Asset Allocation Fund. As a director of asset allocation strategy, Daniel is responsible for overseeing the firm's asset allocation process and communicating the firm's opinions to our clients. These responsibilities include participation on the Capital Market Assumptions Working Group that produces Northern Trust's Five-Year Capital Market Outlook. This product is published annually, and provides our long-term forecast for economic activity and financial market returns for asset classes and economies across the globe.

 As a member of Northern Trust's Investment Policy Committee, Daniel is part of a team of experts across various disciplines and geographic locales that produce long-term asset class forecasts, as well as set tactical and strategic portfolio allocations and recommendations. As a portfolio manager for the Global Tactical Asset Allocation Fund, Daniel is responsible for the management of a globally diversified portfolio. Daniel monitors the asset allocation framework to ensure the allocation is aligned with the firm's evolving investment views and changing market and economic conditions.

 Daniel received his bachelor's degree in finance and economics from the University of Iowa and his MBA in finance, economics, and international business from the University of Chicago. He is a CFA® charterholder.