Overview
The pandemic-induced downward spiral in the credit and equity markets which began in February was halted largely on the strength of historic actions by the Fed and Treasury. By Mid-March they had announced rescue programs including bond buying, interest rates at zero, loan programs, stimulus checks, and enhanced unemployment benefits. The subsequent recovery has been remarkable, with the S&P 500 returning ~60% since the market low. Fed guidance has suggested rates will remain low for the foreseeable future and further stimulus appears likely. An accommodative Fed and Treasury is encouragement for investors to be less risk averse, helping sustain the recovery in equities.
It is truly an unprecedented market environment, making forecasting as challenging as ever. However, some broad conclusions may be drawn. As various prognosticators release updated forward return assumptions, the common theme is lower return expectations across asset classes. This is largely based upon two key metrics: high equity multiples (P/E ratios) and low interest rates. Both valuations are near historic extremes, and a move back towards historic averages is likely to result in below average returns for fixed income and equity.
Review of Long-Term Historic Returns
From 1926 to November 2020, the average 10-year rolling return for a hypothetical portfolio of 60% Stocks and 40% Bonds (60/40) was around 8.7%. As such, an investor might expect that a return target of 8% annualized over the next 10-years is reasonable. As of the most recent year-end, the 10-year performance of a 60/40 portfolio stands at an above average 9.8%.
While returns for the last 10 years might be considered robust, having exceeded the long-term average of 8.7%, the outcome was heavily dependent on maintaining a 60/40 asset allocation throughout the period. Returns for the same portfolio at prior year-end periods can paint a very different picture. For a period beginning just prior to the GFC (as of 12/31/16) the 10-year annualized return was 6.4% and as of 12/31/08 the 10-year annualized return was only 2.1%. The starting point for this latter period coincided with the peak of the infamous “Tech Bubble.” Clearly, having a 10-year investment horizon does not necessarily mean an investor can achieve the historical “long-term” average return.
Future Return Expectations
Equity P/E ratios and interest rates provide a useful gauge as to where we might be in the current cycle. With those as a guide, the current entry point into the market might not seem particularly compelling. However, this does not imply that one should remain in cash or wait for a better time to invest (time the market), but rather that returns over the next decade are likely to be lower than the long-term average (8.7%).
Cash currently yields around 0.1% and the BloomBar US Aggregate is yielding below 1.2%, both under inflation. So provided an investor has at least a 10-year time horizon, achieving even the lowest historical 10-year return for a 60/40 portfolio (2.0% – 2.6%) would exceed current rates for cash or core bonds. However, if the current equity/economic cycle is extended, a 60/40 portfolio should offer more upside vs. cash/bonds.
Such a subdued outlook may inspire investors to reach for returns. Trying to “beat the market” with frequent, short-term tactical trades is a very difficult undertaking. A more prudent approach is to augment a portfolio with non-traditional assets such as Private Equity, Private Debt, Long/Short Equity, and Real Estate. These asset classes carry their own risk and liquidity considerations but can be sources of enhanced returns.
Our Position
Investors should expect that current market dynamics will pose a challenge to achieving even historical average returns. We believe strategic allocation across equities, fixed income and real estate remains the most prudent approach. Depending on each investor’s unique risk and liquidity preferences, however, utilizing non-traditional assets can enhance returns over a more traditional portfolio.
Disclaimers and Legal Notice:
The views expressed herein are those of Asset Consulting Group (ACG). They are subject to change at any time. These views do not necessarily reflect the opinions of any other firm.
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Certain information herein constitutes forward-looking statements, which can be identified by the use of terms such as “may”, “will”, “expect”, “anticipate”, “project”, “estimate”, or any variations thereof. As a result of various uncertainties and actual events, including those discussed herein, actual results or performance of a particular investment strategy may differ materially from those reflected or contemplated in such forward-looking statements. As a result, you should not rely on such forward-looking statements in making investment decisions. ACG has no duty to update or amend such forward-looking statements.
The information presented herein is for informational purposes only and is not intended as an offer to sell or the solicitation of an offer to purchase a security.
Please be aware that there are inherent limitations to all financial models, including Monte Carlo Simulations. Monte Carlo Simulations are a tool used to analyze a range of possible outcomes and assist in making educated asset allocation decisions. Monte Carlo Simulations cannot predict the future or eliminate investment risk. The output of the Monte Carlo Simulation is based on ACG’s capital market assumptions that are derived from proprietary models based upon well-recognized financial principles and reasonable estimates about relevant future market conditions. Capital market assumptions based on other models or different estimates may yield different results. ACG expressly disclaims any responsibility for (i) the accuracy of the simulated probability distributions or the assumptions used in deriving the probability distributions, (ii) any errors or omissions in computing or disseminating the probability distributions and (iii) and any reliance on or uses to which the probability distributions are put.
The projections or other information generated by ACG regarding the likelihood of various investment outcomes are hypothetical in nature, do not reflect actual investment results and are not guarantees of future results. Judgments and approximations are a necessary and integral part of constructing projected returns. Any estimate of what could have been an investment strategy’s performance is likely to differ from what the strategy would actually have yielded had it been in existence during the relevant period. The source and use of data and the arithmetic operations used for calculating projected returns may be incorrect, inappropriate, flawed or otherwise deficient.
Past performance is not indicative of future results. Given the inherent volatility of the securities markets, you should not assume that your investments will experience returns comparable to those shown in the analysis contained in this report. For example, market and economic conditions may change in the future producing materially different results than those shown included in the analysis contained in this report. Any comparison to an index is for comparative purposes only. An investment cannot be made directly into an index. Indices are unmanaged and do not reflect the deduction of advisory fees.
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