Capital Market Assumptions: Expectations for the next 10 years amid a generational change for markets

Capital Market Assumptions: Expectations for the next 10 years amid a generational change for markets

Jeffrey Palma

Head of Multi-Asset Solutions

More by this author

John Muth

Macro Strategist

More by this author
Joseph Handelman

Joseph Handelman

Managing Analyst, Head of Portfolio Solutions

More by this author

22 minute read

June 2024

Share

Sign up to get our insights
Subscribe

We expect higher fixed income and real asset returns alongside lower U.S. equity returns for the next decade.

KEY TAKEAWAYS

  • Our 10-year Capital Market Assumptions reflect higher yields relative to the previous 10 years, stubbornly higher inflation, slower real growth, and higher volatility.
  • Fixed income, driven by the higher current starting point of yields, is expected to have significantly higher annualized returns than the prior 10 years, while U.S. equity returns are expected to be lower given less supportive valuations.
  • We believe real assets are well positioned for stronger annualized returns over the next 10 years amid a more inflationary environment, supportive valuations, and a period of undersupply.

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.

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.

We believe this environment is favorable 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 (Exhibit 1), driven by factors including commodity underinvestment, tight labor 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.

Macroeconomics
Macroeconomics

We expect real gross domestic product (GDP) growth in the United States to average 1.6% annually and global GDP growth to average 3.1% annually. While growth has so far proven resilient to higher rates, we expect it to slow. At the same time, the world has moved away from peak globalization, relative geopolitical stability, quantitative easing and central bank accommodation, which will result in prolonged higher-trend inflation as well as greater macroeconomic volatility.


Fixed income
Fixed income

Fixed income has entered a new return cycle in which rising rates have made assets increasingly attractive. One indication: Our assumptions for U.S. Treasuries call for an expected annual return of 3.9% (unchanged from last year) over the next 10 years. That compares with just 1.7% annualized in the past 10 years.


Equities
Equities

U.S. equities had a remarkable 26.3% return in 2023, raising valuations further and causing us to reduce our 10-year assumptions to 7.0% (from 7.3% in last year’s CMA). While non-U.S. markets have consistently lagged U.S. returns in recent years, we expect total returns to be on par with the U.S. going forward, given a more attractive valuation starting point but lower levels of profitability and slower earnings growth.


Real assets
Real assets

We believe real assets—in particular, natural resource equities and infrastructure— are well positioned in a more inflationary environment. Commodities, we believe, will see a substantial improvement in returns amid undersupply and higher production costs. The lead/lag relationship between listed and private real estate—in which listed leads private in both selloffs and recoveries—is evident in the adjustment we have made from our 2023 assumptions, with a modest decrease in listed real estate expected returns (after an 11.4% return in 2023) and a slight increase in expected private real estate returns (as the market continues to find a bottom).


EXHIBIT 1
Inflation expected to stay above pre-pandemic trend
Inflation expected to stay above pre-pandemic trend

In 2023, we released the first edition of our annual capital market assumptions—our view of the outlook for macroeconomic and financial market conditions for the next 10 years. This process is intended to help inform investment decisions over a strategic time horizon, accounting for the economic backdrop as well as the starting point for asset prices and valuations.

In the sections below, we detail assumptions for the expected returns of the various asset classes we analyze.

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- publicized 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.

EXHIBIT 2
Higher yields driving improved expectations for fixed income

Expected annual returns vs. prior-decade annual returns

Higher yields driving improved expectations for fixed income

Sign up to get our insights delivered to your inbox

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 (Exhibit 3).

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.

EXHIBIT 3
Expected U.S. equity returns no longer exceptional
Expected U.S. equity returns no longer exceptional

Real assets

We see a favorable 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 (Exhibit 4).

EXHIBIT 4
A macroeconomic regime shift is in progress
A macroeconomic regime shift is in progress

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.

EXHIBIT 5
New regime portends stronger real assets returns

Expected annual returns vs. prior-decade annual returns

New regime portends stronger real assets returns
Full 10-year capital market assumptions detail

Expected annual returns vs. prior-decade annual returns

Full 10-year capital market assumptions detail
Expected asset class correlations in detail
Expected asset class correlations in detail
ABOUT THE AUTHORS
Author Profile Picture

Jeffrey Palma, Senior Vice President, is Head of Multi-Asset Solutions, responsible for leading the firm’s asset allocation strategy and macroeconomic research.

Author Profile Picture

John Muth, Vice President, is the firm’s Macro Strategist responsible for providing global macro analysis and forecasts to Cohen & Steers’ investment committees.

Author Profile Picture

Joseph Handelman, Vice President, is a managing analyst for the Cohen & Steers’ real assets multi-strategy and serves as Head of Portfolio Solutions.

FURTHER READING

REITs’ rare earnings multiple discount to stocks is historically compelling

REITs’ rare earnings multiple discount to stocks is historically compelling

June 2024 | 10 mins

U.S. equities have outperformed U.S. listed REITs substantially over the past few years. But history suggests that the resulting valuation gap between equities and REITs indicates a likely reversal.

The active advantage in listed REITs

The active advantage in listed REITs

May 2024 | 14 mins

The diversity and complexity of the real estate market give specialist active managers a wide field of opportunities to potentially enhance returns.

Putting recent headlines on private real estate valuations into context

Putting recent headlines on private real estate valuations into context

May 2024 | 4 mins

A generational reset in commercial real estate prices is in full swing, with conditions pointing to further declines, setting up strong vintage-year return potential for private funds with fresh capital.

3613656