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SUMMARY
- Our US long-term stock return forecasts are mildly lower than last year.
- International forecasts slightly higher, except for emerging markets.
- Fixed Income returns significantly higher than in previous years.
RiverFront is proud to release our 2024 Long-Term Capital Market Assumptions (‘CMAs’). At RiverFront, we believe in ‘Process over Prediction.’ This is the idea that a dynamic investment process built to adapt to unexpected events is more important to long-term investment success than being bound by any particular forecast. Nonetheless, we view long-term (5-7 year forward) capital forecasts as a useful part of our process to help identify and monitor what we think are important long-range drivers for markets. In this summary we deliver an update to our capital market assumptions (see summary table on chart 2, below) from March 2023, with an emphasis on what has changed in the macroeconomy and in our forecasts since our last update.
Long-Term Base Case: Stocks Slightly Lower than ’23 Forecast… Bonds Much Higher
Our ‘Base Case’ total return for US large-cap stocks over the next 5 to 7 years is down somewhat from our March 2023 forecast (see chart, below). This is primarily due to higher starting valuations, as markets have rallied double digits since then.
Our research suggests to us that higher starting points for stock valuations can lead to lower long-term future returns. However, our long-term forecast for US bonds is dramatically higher than just a couple years ago. This is a function of meaningfully higher yields, which should equate to higher total returns if held to maturity. Non-US stock forecasts are little changed from last year, with the exception of our lower forecast for emerging markets, which continues to suffer from economic, demographic, and geopolitical issues in China.
Our US Stock Forecast in Line with Higher Valuation Periods
Some might say our Base Case for US Stocks of +7.0% annualized return over the next business cycle (see green bar, chart below) seems low compared to the average 7-year return from 1925-present of over 10% (see blue bar, chart below). However, our forecast is more commensurate with an average of 7-year forward historical returns at times when the S&P 500 was in the most expensive quintile (top 20%) of starting valuations, as they are now (see orange bar, chart below). This gives us some confidence that we are in the right ballpark with our estimates.
Key Inputs: Inflation Likely to Be Structurally Higher
Our longer-term view on inflation is one key input to our long-term forecasts. While we believe that the ultra-high inflation levels of 2020-2022 were related to pandemic imbalances and will continue to moderate, we also believe core inflation will average above 2% over the next 5-7 years, across all three of our scenarios. This is related to a host of factors, including the advent of ‘onshoring’ and ‘friendshoring’ (shifting supply chains to domestic or to geographies perceived as aligned with the US), as well as reasonable global economic growth.
We believe the low inflation levels experienced from 2008 to 2020 (blue trend line) were an anomaly, driven by China’s entrance into world trade with a large low-cost workforce unlikely to be replicated again. For this reason, we anticipate that inflation will return to something resembling its long-term historical trend (see chart right). Inflation has trended at or above 2% per annum for most of the US’s history, other than directly after WWII and two deflationary periods in the late 1800s and early 20th century (orange lines).
Key Inputs: Terminal 10-Year Rate Around 5%
Another key input to our long-term forecasts is our view on the ‘terminal’ interest rates on US government bonds (where rates will be at the end of the forecast period). In our Base Case, by the end of the 5-7 year forecast horizon, we expect the US 10-year treasury to yield around 5%, more in line with long-term historical averages. If we are correct, this assertion has meaningful impacts on asset allocation and security selection. When we analyze 10-year Treasury yields since 1962, the data suggests to us that the worst of the downside in bond prices is behind us, and that long-term balanced investors will be rewarded by owning bonds again. Classic yield plays like staples and utilities may struggle, beneficiaries of higher rates like financials may do better, and stable, high cash flow growth companies should continue to do well.
Key Inputs: Earnings Growth Remains Near Trend
Yet another key input to our long-term forecasts is our view on how corporate earnings trend over our forecast horizon. Our Base Case for US Large-cap stocks assumes around 7.0% earnings growth per year across the forecast period. This is slightly lower than the trend of roughly +7.7% over the time period from 1985-to present (see lighter blue line in chart), but still represents what we would consider to be solid trend growth through the next business cycle. Our Bull Case assumes stronger earnings of around +10% per year, commensurate with a stronger economic backdrop and lower interest rates. Our Bear Case assumes trend earnings of just +3.5% per year, as the below-trend economic growth, higher inflation and interest rates and higher US dollar assumed in that scenario would sap corporate earnings power.
Risk Discussion: All investments in securities, including the strategies discussed above, include a risk of loss of principal (invested amount) and any profits that have not been realized. Markets fluctuate substantially over time and have experienced increased volatility in recent years due to global and domestic economic events. Performance of any investment is not guaranteed. In a rising interest rate environment, the value of fixed-income securities generally declines. Diversification does not guarantee a profit or protect against a loss. Investments in international and emerging markets securities include exposure to risks such as currency fluctuations, foreign taxes and regulations, and the potential for illiquid markets and political instability. Please see the end of this publication for more disclosures.