Find below a comment by César Pérez Ruiz, Chief Investment Officer, Pictet Wealth Management.
This year’s edition of Horizon presents Pictet Wealth Management’s vision of strategic asset allocation issues and provides 10-year forecasts and analysis for over 50 asset classes across bonds, equities, alternatives and cash in five currencies.
Strategic asset allocation
Based on the belief that an understanding of the interconnection between rapid changes in the geopolitical, financial and environmental landscape should be the starting point of any investment journey, the 2024 Horizon looks at the deep-rooted shifts in the drivers of growth and inflation. In particular, we look at the implications of a new regime of more volatile inflation for monetary policy and secular growth.
We also look at what the US’s growing debt burden could mean for the world’s biggest economy over the next decade and examine the likely fallout from the progressive weakening of the post-World War II global order. The revival of industrial policy as western countries try to ‘re-industrialise’ and the re-ordering of global supply chains also come under the microscope. In addition, Horizon delves into what the AI revolution could mean for innovation and productivity and how the (uneven) shift away from fossil fuels comes with opportunities…but also risks.
Long-term asset-class returns
Nominal return forecasts for the next 10 years are forecast to be generally attractive across the main asset classes as well as for ‘alternative’ investments, with rich potential seen in areas such as infrastructure and private real estate.
Our forecasts for government bonds are coloured by our belief that central banks will be relatively cautious about cutting interest rates over the next year given the risk to their credibility should we see a resurgence in inflation. In addition, our analysis shows structural issues will mean that consumer inflation in the US persistently exceeds the Fed’s 2% target over the next 10 years, with the sustainability of debt burdens another issue. With these considerations in mind, we see 10-year US Treasuries providing an annual nominal return of 4.4% on average over the next 10 years (in USD), and an average real return of 1.9%, once inflation is taken into account. At 4% on average (in GBP), UK gilts could also offer attractive nominal returns. In most cases, government bonds should offer higher nominal returns than cash over the next 10 years, although in Germany the gap could be relatively slight (2.3% on average for 10-year Bunds versus 2.1% for cash). In this year’s edition of Horizon, we take a look at the chance that investors demand extra compensation for holding long-term US Treasuries given the surge in the federal deficit. Yet government bonds are seen as playing a protective role in balanced 60/40 portfolios.
Investment-grade corporate bonds should be a source of extra yield. Our conclusions is that investment-grade bonds in the US will provide an average annual return of 5.4% and euro investment-grade bonds 3.7% (nominal returns in local currency) over the next 10 years. Both figures are higher than our forecasts for the equivalent government bonds. Given their higher risk, we believe noninvestment-grade bonds will provide higher returns over the next 10 years (6.4% in the US and 5.5% on average in local currency terms). In general, however, we consider that investment-grade bonds offer superior risk-return profiles than noninvestment-grade ones. We see USD-denominated corporate debt in emerging markets producing an average return of 6.9% over the next decade (5.9% in Asia outside Japan).
In equities, some of the highest annual returns are seen as coming from emerging-market equities and global small caps. But developed-market equities should not be sniffed at either. We see average annual returns of 7.7% for Swiss equities, 7.2% for equities in the euro area and 6.5% for US equities over the next 10 years (nominal return forecasts in local currency). At 8.4% on average (in USD), emerging-market equities should do even better, while we see global small-caps providing annual returns of 7.3% over the coming 10 years.
We see a number of issues coming to the fore in equity investing. These include the sustainability of high profit margins and concerns in some quarters that we are in the midst of a market bubble (in a nutshell, investors should not assume that markets will continue to rise over the next 10 years without a major correction and should prepare accordingly). The increase in funding costs and the temptation for cash-strapped governments to target companies reporting high margins and profits will be worth monitoring. Our conclusion is that dividends and share buybacks will account for a growing share of total shareholder returns over the next 10 years—over 50% in the case of US and European equities.
As for ‘alternatives’, our analysis shows that private equity should manage to overcome a challenging couple of years and perform handsomely in the 10 years ahead. We are pencilling in average annual returns of 10% for this asset class (in USD), higher than our forecast for public equities. Global hedge funds (6.2% on average) may provide marginally lower returns than equities, but they offer interesting, uncorrelated rewards and can help reduce a portfolio’s overall volatility. At the same time, we continue to see the merits of holding gold as a strategic asset, especially in view of a fraught geopolitical scene and growing debt worries. We see gold as providing an average annual return of 3.1% (in USD) in the next 10 years.
