There’s a lot going on in world markets and investment decision making just now.
In this detailed big-picture analysis, Jeffrey Palma (pictured), head of multi-asset solutions at Cohen & Steers, looks to the future and makes some bold investment predictions for the next decade. Talking us through the outlook for sectors including fixed income, equities, and real assets, Palma provides some unemotional and rational clarity as to where he believes the global markets are heading – and why.
Here at Cohen & Steers, our capital market assumptions for the next ten years reflect that the past two years have ushered in a generational change for markets.
Gone are near-zero interest rates, low inflation, stable growth and long economic cycles that were observed for well over a decade.
Taking their place: higher and more normal yields, increased economic volatility, risks of inflationary surprises, greater geopolitical uncertainty and a resetting of asset prices. Indeed, the post-GFC low/ zero interest rate world appears to be far in the rearview mirror.
The landscape we envisioned for the next decade when we released our inaugural capital market assumptions last year—one characterized by slower economic growth alongside higher and more volatile inflation—remains largely in place. As is typically the case when long-term projections are updated, there have not been major shifts in our return expectations across asset markets.
What a difference a year makes
At this time last year, few market observers predicted the resilience of the U.S. economy or such high yields. Perhaps most significantly, inflation has also proven stickier—an indication, we believe, of what to anticipate in coming years.
Now, after two years of aggressive central bank actions intended to tame inflation, we believe the rate-hiking cycle is likely ending. To be sure, market expectations on central bank policy have shifted significantly from the start of 2024 to the time of this writing. Regardless of the timing or number of rate cuts, the bottom line is that we are very unlikely to return to previous levels of accommodation.
Echoing our view from last year, we believe that fixed income now provides a higher-return alternative to other asset classes than was the case for most of the previous decade. Equity returns, by comparison, are expected to be lower, facing elevated valuations, slower growth and a higher cost of capital.
The case for real assets
We believe this environment is favourable for real assets. The starting point on valuations is more attractive. And, whereas forecasters have consistently been too optimistic about inflation falling, we expect stickier inflation going forward, driven by factors including commodity underinvestment, tight labour markets, geopolitics and deglobalization.
Investors today also face a much more difficult return environment. Diversifying beyond stocks and bonds with real assets is likely to become increasingly important in creating more efficient portfolios.
Fixed income
The new regime of higher rates and higher-trend inflation has mixed implications for fixed income returns. The good news for Treasury investors is that the rise in interest rates in 2022 and 2023 means that capital losses are likely behind us, and higher current yields are expected to generate good returns (3.9%) over the next decade.
That’s a significant difference from the previous regime (spanning 2012–2021), when there were only three months in which 10-year U.S. Treasuries closed with a yield in excess of 3%. Following the growth and inflation rebound in the post-Covid era, alongside aggressive Fed (and other global central bank) tightening, short-term rates have shifted higher, even brushing up against 5% in 2023.
While a higher-for-longer cyclical environment has dominated market attention of late, we believe neutral real rates are slightly lower than current levels, suggesting Fed easing is probable in coming years. Regardless of any view on the timing and number of rate changes, the key assumption is that we do not expect a decline in rates back to pre-Covid levels. Indeed, our base case anticipates a terminal fed funds rate of around 3% over the next 10 years.
The starting point for corporate credit markets is also relatively attractive from a yield perspective. Our return forecasts for investment grade and high yield are roughly unchanged from last year, and these markets appear poised to outperform Treasuries. However, it is worth noting that the starting point on spreads poses some shorter-term risks in a slower-growth environment, which could lead to spread widening and, ultimately, a cyclical uptick in defaults.
Preferred securities had a strong year in 2023, returning 8.2% despite the well-publicised banking sector turmoil in the first quarter. Looking ahead, we see good reasons to remain optimistic about preferreds’ return potential, including strong fundamentals, attractive valuations and the end of the rate-hiking cycle.
Equities
Global equity markets face several crosscurrents in the years ahead. On one hand, strong nominal growth—courtesy of real growth and somewhat higher inflation—should support top-line growth, particularly in the U.S., even if some margin compression is possible from currently elevated levels.
However, the starting point for valuations is less supportive in a higher–yield interest rate regime and given 2023’s strong performance, more than half of which is attributable to multiple expansion. Combined, this suggests U.S. equity returns of 7.0% over the next decade—down slightly from our 2023 assumption of 7.3%, and far lower than the prior 10 years’ annualized returns of 12.0%.
Non-U.S. markets have somewhat different drivers. For developed international equities, we anticipate slower-trend earnings growth (compared with the U.S.) due to declines in working-age population growth and relatively lower productivity. However, these markets have higher dividend yields and more attractive valuation starting points to support returns.
Therefore, we expect developed international equities’ total returns to be on par with the U.S. That’s in contrast to the prior 10 years, when U.S. equity returns were much higher. Despite persistent underperformance, we believe emerging markets will continue to lag in coming years, given a continuation of structurally lower return on equity and potential headwinds to growth in China.
Real assets
We see a favourable backdrop for real assets, supported by several key pillars (including stickier inflation and improved diversification of traditional portfolios). Moreover, we continue to believe that real assets valuations are attractive. Even without relying on multiple expansion, real assets should be able to post strong returns driven by growth and profitability.
Further, the world has transformed from an era of abundance marked by lower wages, commodity overinvestment, low inflation and relative geopolitical stability, among other factors. We are now in a regime characterized by “scarcity,” with higher inflation, higher wage price pressures, a move away from peak globalization and more geopolitical uncertainty. This is a backdrop that is likely to support higher real assets prices.
For U.S. listed REITs, we expect annualized returns of 8.0% over the next 10 years—only marginally lower than our forecast last year. Global listed REITs are expected to be similar (8.1%) given a slightly higher dividend yield and better valuations after lagging returns in 2023.
Listed and (core) private real estate returns tend to be similar over the long run, reflecting the similar nature of the asset classes. However, the substantial decline in listed markets in 2022 stood in sharp contrast to private markets, which actually posted positive returns given the lagged nature of asset valuations in reported results. During 2023, these trends reversed, with listed markets rising—particularly in the fourth quarter—while private market returns were negative. As a result, going forward, we expect somewhat higher returns in private markets (7.3%) than was the case last year.
Expected total returns for global listed infrastructure also appear attractive at 7.8%.
We expect commodity prices to be supported by the secular backdrop—this includes underinvestment in supply in recent years, investment in energy transition, and global geopolitics. For commodity returns, a higher level of interest rates also boosts the expected return on collateral, offset slightly by some drag from the roll yield.
Strong natural resource equity returns (8.8% over the next decade) should be supported by commodity prices, as well as by low current valuations and very high free cash flow growth.
