Almost two years after the pandemic struck, the global economy has suffered limited scarring, but policy interventions at the height of the health crisis have an enduring impact on the economy and asset markets, according to a new report.
In its 2022 Long-Term Capital Market Assumptions, J.P. Morgan Asset Management (JPMAM) says it expects annual returns on investments to remain low by historical standards. With a 60/40 portfolio (60% in MSCI All Country World Index and 40% in Bloomberg US Aggregate) projected to return 4.3%, investors need to look beyond traditional asset markets to find higher returns, the report says.
Higher inflation numbers are eating into fixed-income returns, and investors should broaden the tool kit for returns by looking into alternative assets and incorporating private investment as a part of overall portfolios, according to the report, which provides a 10- to 15-year outlook for risks and returns of more than 200 asset classes.
“This year, we raised long-term inflation projections for the first time in many years. Despite high inflation and low return expectations in public markets, we see plentiful opportunities for investors who are willing to expand opportunity sets beyond publicly traded assets and core markets,” says JPMAM global multi-asset strategist Patrik Schöwitz.
“Our return forecasts for alternative assets compare favourably with public market returns. The benefits of alternative assets – improving alpha trends, the ability to harvest risk premia from illiquidity, and the opportunity to select managers that can deliver returns well above what is available from pure market risk premia alone (beta) – will continue to attract capital over the coming decade,” he adds.
Global multi-asset strategist Sylvia Sheng believes China offers an attractive proposition for those seeking to diversify return sources beyond core markets. “Given the near-term economic slowdown and regulatory uncertainties, China represents more of an alpha story than a beta story,” she says. “Despite the short-term volatility, the strategic investment case for Chinese assets remains strong. Over the longer term, we expect China’s onshore equities and bonds to return a sizeable premium over core developed markets and become more mainstream in global portfolios, fuelled by further capital market reforms and opening and attractive return and diversification opportunities.”
The report forecasts a 2.2% real GDP growth for a set of economies over the next 10 to 15 years, compared with 2.9% from 2010 to 2020 and 2.7% from 2000 to 2020. It expects aggregate developed-market growth (1.5%) to run close to its track record in recent years, but aggregate emerging-market growth to be lower than in the past 20 years (3.7% against 6.0% during the 20 years to 2020), partly driven by China’s ongoing deceleration.
For the first time in many years, JPMAM raises its long-term inflation projections to 2.4% (up from 2.2%), and it now sees less risk of persistent deflationary pressures. “We detect a different inflationary dynamic: post-recession, output gaps are closing quickly; meanwhile, stimulative fiscal and monetary policies are working in partnership. The inflation manifesting itself in the late stages of the Covid-19 pandemic is proving a little stickier than central banks expected,” it says.
On the impact of policy interventions, the report says: “The very same bold fiscal and monetary policy that propelled us out of the pandemic gloom represents a seismic and lasting evolution of economic policy. Gone is a decade of sluggish capex, periodic austerity and weak productivity, offset by loose monetary policy. In its place, we find an emphasis on nominal growth and a greater willingness to tolerate larger balance sheets and higher levels of government debt than we’ve seen since 1945.
“Emboldened by their pandemic policy success, governments are now focused on medium-term ambitions. Multi-year spending plans have already been laid out with an emphasis on rebuilding crumbling infrastructure, addressing social inequality and tackling climate change.”
Equity returns to fall
On equities, JPMAM expects China A-shares to deliver an annual return of 6.6% in local currency terms and 8.2% in US dollar terms, up from 6.3% and 7.5%, respectively, last year. Return for US large caps will remain unchanged at 4.10%, while that for the euro area will rise 60bp to 5.80%. It sees a 10bp cut to 5.00% in Japan, and a hefty adjustment of 260bp to 4.10% for UK stocks.
Emerging-market returns are forecast to dip 20bp to 6.60%. All these changes combined will pull global equity returns down by 10bp to 5.00% in USD terms, the report says.
Turning to fixed income, JPMAM says the outlook for government bonds remains dire, but nominal bond returns will improve from 2021. It forecasts 10-year US Treasury returns to rise 80bp to 2.40%, and USD cash returns to increase 20bp to 1.30%. “Nevertheless, given our US inflation estimate of 2.30%, this still implies negative real returns for cash and virtually zero real return for treasuries, on average, across our forecast horizon,” it says.
Outside the United States, the report sees a bleak picture, with nominal returns of just 1.30% for 10-year government bonds in the euro area and 1.70% for 10-year UK government bonds, implying significantly negative real returns. However, Chinese government bonds (CGBs) will be an exception, with a forecast return of 3.4%.
JPMAM says financial alternatives offer a marked uplift compared with public markets, with cap-weighted private equity returns up 30bp from last year, at 8.10%, and private debt offering 6.90%. It forecasts private debt to deliver a 10bp return over 2021, and a much more favourable uplift when compared with public credit returns.
“While financial alternatives generally do have an equity beta, the additional returns available from manager selection can deliver a meaningful boost to portfolios,” the report says. “Real assets continue to stand out as an opportunity set that is both attractively valued – not having participated fully in the post-pandemic risk rally – and also likely to be resilient in multiple future states. In the near term, strong income streams in real estate, infrastructure and transportation assets are welcome when bond yields are compromised.”