We consider the following factors when developing our 7-year forecasts.
Interest rates are likely to decline from current levels but will remain at higher levels for longer versus the past ten-year average.
Labor shortages persist in service-oriented industries and may constrain margin expansion.
Energy prices are likely to be higher vs. the prior cycle given structural supply shortages.
Geopolitical uncertainty is increasing with regards to the US-China relationship and potential for episodic military conflicts.
With equity valuations having increased materially during H1 2023, we expect mid-to-high single digit nominal pre-tax annual equity returns (6.5%-7.5%) over a seven-year forecast period.
We continue to anticipate greater convergence between US and International equity market returns.
While we expect quality and growth stocks to outperform value stocks over the forecast period, the rate of outperformance is likely to be lower than in recent years.
Equity market valuations are generally fair (for international markets) to modestly overvalued (US).
As such, expected returns are likely driven by earnings growth and dividends rather than multiple expansion.
Potential wildcards (especially for tech-oriented US markets) include adoption pace surrounding generative AI and the resultant potential for above-trend revenue growth and margin expansion.
“Safe” fixed income remains attractive, especially for shorter-term maturities.
US and Canadian 1-year government bond yields are yielding 5.2% to 5.3% and 2-year government bonds are yielding 4.6%-4.8%.
We still expect mid-single digit returns for US government debt and investment grade bonds over the forecast period.
On a risk-adjusted pre-tax basis, safe fixed income is still attractive relative to equities.
Riskier credit assets (high-yield bonds and leveraged loans) are somewhat attractive over a mid-term time frame (and on a relative basis to equities).
US high-yield bonds are now yielding 8.2% with 7-year forecasted annual returns of 6.5% (relatively close to US Equities). Leveraged loans are currently yielding 10.4% (based on 3-year takeout convention) with expected mid-term annualized returns in the 7.0% range.
However, on a nearer-term basis (next 12 months), high yield bonds and leveraged loans may experience declines and heightened volatility if credit spreads widen further were a deeper than expected recession to occur.
For new private market strategies (i.e., private equity, private credit, real asset funds), we continue to forecast higher returns relative to public markets (over a multi-year timeframe).