Seven-year forecast examines the strengthening of U.S. economy, the influence of inflation on fixed income investments, and positive trends in emerging markets
Chart: U.S. remains the dominant global economy
Chart: Forecast of annualized performance of selected asset classes from 2015 to 2021
Chart: Low return expections and low volatility projected for bonds
The report, crafted by the Wilmington Trust’s Investment Strategy Team, forecasts a strengthening United States economy, marked by steady, positive developments, as well as persistent challenges, resulting in a prolonged, subdued recovery. Second, on the cusp of a rising interest rate environment, the firm anticipates persistently low inflation, which would keep both yields and returns for fixed income investments relatively modest. Third, the report projects that emerging markets on the whole are poised to prosper, particularly relative to developed markets.
“Before the financial crisis, having stocks and bonds in a portfolio often sufficed in terms of diversification,” said Tony Roth, Wilmington Trust’s chief investment officer. “But these are not your father’s capital markets anymore. Some of the old rules no longer apply, particularly in an environment where we’re expecting an extended period of low inflation, low bond yields, low bond returns, and muted equity returns. That said, we see plenty of opportunities to unearth in this slow but steady growth environment.”
United States once again the dominant global economy
The 2015 Capital Markets Forecast examines how the U.S. remains a global economic leader despite slow growth due to challenges such as the labor market and sluggish housing market. With a stronger U.S. economy, comes a stronger dollar, which is likely to continue to appreciate against other developed markets like Japan and Europe. The more powerful greenback means increased capital flows into the U.S., which should have a positive effect on domestic stock prices.
Additionally, the decrease in the price of oil has freed up consumers to spend more money beyond the gas pump. The downward pressure on energy prices is a harbinger for long-term benign inflation expectations, as well as modest growth expectations stemming from higher oil demand. Wilmington Trust sees cyclicals like industrials, technology, and consumer discretionary as likely to benefit from strong productivity and growth trends.
Low return expectations for bonds, but low volatility keeps them in the game
The report predicts inflation will average 1.9 percent, with higher rates toward the end of the seven-year forecast period. In the shorter term, inflation is expected to be compressed as workers are likely to have little pricing power, and residual global slack weighs on prices.
While bond yields have moved lower during 2014, Wilmington Trust foresees a rise in yield levels in coming years. Nominal yields for 10-year government bonds, currently at 1.9 percent, are anticipated to peak at 3.5 percent during the next seven years, while real returns are anticipated to range from near-zero to negative, both domestically and internationally.
Return prospects for investment-grade and speculative-grade corporate bonds, including floating rate securities should range from 3 to 6 percent annually—higher than government securities, but still quite low on a historical basis. Performance for international developed market debt should be even lower than that of the U.S. as the combination of very low starting yields and currency depreciation should hurt performance for dollar investors.
Wilmington Trust’s Investment Strategy Team continues to favor equities with the expectation that their level of commitment will only modestly exceed market weights. The 2015 Capital Markets Forecast predicts modest stock returns in the mid-single-digit vicinity, but this is more than we can forecast for bonds for the next few years.
Emerging markets forecast to outperform developed markets
Wilmington Trust’s Investment Strategy Team expects a convergence between developed and emerging markets. This will likely be accomplished by emerging markets emulating economic policies that have worked well in developed markets. Emerging markets are expected to experience generally solid income, productivity, and economic growth, presenting an area of opportunity.
The Capital Markets Forecast predicts that emerging markets won’t keep pace with their growth rate of the last 15 or so years, which was aided by cheap labor, prolific exports, and underdeveloped economic infrastructures. Over the last few years, rising wages have cut into profit growth, resulting in poor financial market performance. Emerging market economies, however, continue to need basics, so they are expected to sustain higher growth rates than developed economies.
Mexico, Korea, and Southeast Asia are emerging markets that should develop and come to the forefront in the near term. Many of the economic models that worked for China are being implemented in these regions. China and India are expected to move toward greater liberalization, which would create positive economic changes that should become more apparent in a few years.