Our Capital Market Assumptions reflect that we are in the early stages of a significant and far-reaching macroeconomic regime change.
KEY TAKEAWAYS
- Our 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 facing slower growth and a higher cost of capital as well as higher risk premia.
- 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 10 years reflect that we are in the early stages of a significant and far-reaching macroeconomic regime change that was set in motion over the past three years.
A mismatch between high demand (driven by monetary stimulus) and impaired supply in the wake of the pandemic and the war in Ukraine, on top of longer-term demographic, geopolitical and economic shifts caused inflation to spike. The Federal Reserve and other central banks responded by raising interest rates and moving from quantitative easing to quantitative tightening.
While we are past peak inflation, we believe the risks of bouts of inflationary shocks over the next decade have increased. In our view, this new period will be marked by labor scarcity, commodity underinvestment, increased geopolitical uncertainty, and a move away from globalization and toward “friend-shoring” (i.e., trade partner selectivity).
Stubbornly higher inflation will likely result (Exhibit 1, page 3). We also factor in higher interest rates and lower real economic growth than in the last cycle in U.S. and global economies. We believe greater volatility of macroeconomic factors and the global business cycle will also lead to more frequent cycles of slowdown and expansion versus what investors became accustomed to in the prior 35 years. In turn, this drives several notable aspects of our 10-year assumptions that differ from the prior decade, including higher yields, generally lower multiples and higher premiums for risk assets.
Key differences from the prior 10 years include:
| Macroeconomics | We expect real gross domestic product (GDP) growth in the United States to slow to 1.6% annually and global GDP growth to average 3.1% annually. We also forecast more volatility (particularly in macroeconomic factors) as the world moves away from peak globalization, relative geopolitical stability, quantitative easing and central bank accommodation. |
| Fixed income | Fixed income, driven by the higher current starting point of yields, is expected to have significantly greater annualized returns than in the prior 10 years. U.S. Treasuries are a good example, having returned just 0.7% annualized in the past 10 years. Our assumptions indicate an expected annual return of 3.9% over the next 10 years. |
| U.S. equities | U.S. equity returns are expected to be lower amid slower growth, lower profit margins (given higher operating expenses) and a higher cost of capital, as well as higher risk premia. We forecast improved returns for international equities due to faster growth potential and more attractive valuations today. |
| Real assets | We believe real assets—in particular, natural resource equities and infrastructure—are well positioned in a more inflationary environment, driven by higher levels of profitability and a more supportive valuation backdrop. Commodities, we believe, will see a substantial improvement in returns in a period of undersupply and higher production costs. We expect average private core real estate returns to moderate. |
EXHIBIT 1
Inflation expected to stay above pre-pandemic trend
As of 12/31/2022. Source: Bloomberg, Cohen & Steers.
Our Capital Market Assumptions for the next 10 years reflect that we are in the early stages of a significant and far-reaching macroeconomic regime change.
In the sections below, we detail assumptions for the expected returns of the various asset classes we analyze.
A closer look at fixed income
We expect fixed income returns to be higher over the next 10 years (Exhibit 2), and this assumption centers on the higher starting point for yields that exist today.
As inflation has risen, the Federal Reserve has engaged in one of its most aggressive rate-hiking cycles ever, which raises forward-return prospects across the fixed income universe.
Our expectation is that inflation will settle out around 3%, driven by prevailing supply-side shortages in goods, commodities, housing and labor. The Fed will have difficulty achieving its old, and likely outdated, 2% inflation target on a sustained basis.
As such, we don’t expect the return to normalization that the general market anticipates.
3.9% Expected 10-year annualized returns for U.S. Treasuries
EXHIBIT 2
Higher yields driving improved expectations for fixed income
Expected annual returns vs. prior-decade annual returns
As of 12/31/2022. Source: Refinitiv Datastream, Bloomberg, Cohen & Steers. Past performance is not a guarantee of future results. Forecasts are inherently limited. There is no guarantee that any market forecast will be realized.
A closer look at equities
While yields are a rising tide that we expect to lift fixed income returns across the board, our expectations for equities are more subdued.
During the prior decade, earnings grew strongly, profit margins expanded, and multiples climbed. However, quantitative easing and accommodative monetary policy are gone, while growth is slowing. Slowing labor force growth will hold back economic growth, absent a strong revival in productivity. One development we are watching that could influence productivity is artificial intelligence (AI), with some observers estimating that productivity gains in AI could offset the expected decline in the labor force.
Our 10-year expectation for U.S. real GDP growth is 1.6%, down 0.5 percentage points from the prior decade. Global GDP growth is also expected to be lower than the prior decade at 3.1%, down 0.6 percentage points from the pre- pandemic trend. The primary driver of slowing U.S. and global real GDP growth is a decline in working-age population growth.
As growth slows, costs are rising amid higher inflation. Notably, the labor share of income is climbing higher after a multi-decade trend lower, and companies are seeing lower net profit margins. A higher cost of capital is also likely to act as a restraint on profitability and earnings growth.
At the same time, a higher required risk premium will also likely drive down equity multiples. In other words, higher rates mean that investors can achieve higher yields with lower risk in fixed income, making risk assets, notably equities, relatively less attractive.
That’s particularly true for U.S. equities, where our assumption is for annualized returns of 7.3% over the next 10 years. These returns are only slightly above our assumption for emerging markets (7.2%) and are lower than that for developed international markets (7.7%); in these markets, valuations are relatively lower now and don’t need to adjust down, unlike valuations in
U.S. equities. Expected returns stand in stark contrast to the prior decade, when U.S. equities outperformed emerging and developed international markets substantially (Exhibit 3).
7.3% Expected 10-year annualized returns for U.S. equities
EXHIBIT 3
Expected U.S. equity returns no longer exceptional
As of 12/31/2022. Source: Refinitiv Datastream, Bloomberg, Cohen & Steers. Past performance is not a guarantee of future results. Forecasts are inherently limited. There is no guarantee that any market forecast will be realized.
Implications for real assets
The new market regime is driving higher expected returns for real assets (Exhibit 4).
Higher production costs, increased regulation, a scarcity of resources, and recent underinvestment will drive returns in natural resource equities and commodities over the next 10 years. At the same time, resource producers have faced revenue pressures for years and have instilled greater supply-side discipline and a greater focus on profitability. Better growth and higher profitability also support valuations of resource equities.
Higher expected returns for commodities, as measured by the Bloomberg Commodity Index, are also driven by higher production and extraction costs, which are the result of inflation, as well as by a longer-term shift as we move from a period of oversupply to one of undersupply. Higher expected collateral returns (in light of higher expected interest rates) will also contribute to commodity total returns.
We also expect infrastructure to perform well given predictable cash flows and the fact that many infrastructure subsectors—such as airports, marine ports, midstream energy, toll roads and towers—have revenues that adjust with inflation.
Indeed, infrastructure has historically produced above-average returns when inflation has been high but moderating. We also expect investor demand for infrastructure to remain high, as the asset class generally has lower volatility than the broader stock market due to its relative earnings stability.
In the expected higher-inflation/lower-growth environment, we believe that REIT cash flows will remain resilient and that constrained new supply will benefit real estate prices (though lower economic growth could be a modest headwind). We expect U.S. REIT returns to improve over the prior decade (8.2% vs. 6.9% annualized returns), while global REITs, benefiting from more attractive valuations in international markets, are expected to improve more sharply (8.0% vs. 3.8% annualized returns).
Listed and private real estate returns tend to be similar over long periods, but private real estate typically lags listed real estate due to its slower-moving price discovery and transactions. Listed real estate had sharp declines in 2022, while private real estate had only modest declines. We expect average private core real estate (7.0% vs. 9.7% annualized returns) to trail listed markets as this gap closes.
EXHIBIT 4
New regime portends stronger real assets returns
Expected annual returns vs. prior-decade annual returns
As of 12/31/2022. Source: Refinitiv Datastream, Bloomberg, Cohen & Steers.
Full 10-Year Capital Market Assumptions detail
Expected annual returns vs. prior-decade annual returns
Past performance is not a guarantee of future results. Forecasts are inherently limited. There is no guarantee that any market forecast will be realized. (1) 2013–2022 performance (1/1/2013–12/31/2022) represented by the following: Fixed Income: Cash: Bloomberg Barclays U.S. Long Government/Credit Index. TIPS: U.S. Treasury Inflation Notes Index. Treasuries: Bloomberg Barclays U.S. Treasury 7-10 Year Index. Corporate bonds: Bloomberg Barclays U.S. Aggregate Corporate Index. High yield bonds: Bloomberg Barclays U.S. Corporate Investment Grade Index. Preferred securities: ICE BofA Fixed Rate Preferred Securities Index. Long-Term Treasury: Bloomberg Barclays U.S. Treasury Long Bond Index. Long- Term Corporate: Bloomberg Barclays U.S. Long Treasury Index. Equities: U.S.: S&P 500 Total Return Index. EAFE: MSCI EAFE Index. Emerging Markets: MSCI Emerging Markets Index. Real Assets: U.S. REIT: FTSE Nareit Equity REITS Index. Global REITs: FTSE EPRA Nareit Developed Real Estate Index. Infrastructure: UBS Global 50/50 Infrastructure & Utilities Index (net) through March 31, 2015, and the FTSE Global Core Infrastructure 50/50 Net Tax Index for periods thereafter. Natural Resource Equities: S&P Global Natural Resource Equities Index. Commodities: Bloomberg Commodity Total Return Index. Private Real Estate: NCREIF ODCE Index.
Expected asset class correlations in detail
Forecasts are inherently limited. There is no guarantee that any market forecast will be realized.
ABOUT THE AUTHORS
Jeffrey Palma, Senior Vice President, is Head of Multi-Asset Solutions, responsible for leading the firm’s asset allocation strategy and macroeconomic research.
John Muth, Vice President, is the firm’s Macro Strategist responsible for providing global macro analysis and forecasts to Cohen & Steers’ investment committees.
FURTHER READING
3 Reasons to own real assets
A diversified blend of real assets can potentially play a vital role in the new regime of higher inflation, higher rates and increased market volatility.
Secular drivers of inflation
Recent data indicates a slowing inflation trend, yet risks persist. Secular forces suggest that a prolonged elevated inflation period is underway with the potential for periodic price spikes. Factors driving long-term inflation include commodity underinvestment, tight labor markets, geopolitics, deglobalization and fiscal uncertainty. We see parallels to past inflationary eras, which highlight the difficulty of controlling inflation. While not predicting a return to 9%, the expectation is for a decade of higher-than-accustomed inflation, underscoring the importance of having a real assets allocation.
Opportunities in the era of scarcity
The world is transitioning from an era of commodity abundance to one of undersupply. We believe this shift may result in significant returns for commodities and resource producers over the next decade.
IMPORTANT: The capital market assumptions regarding the likelihood of various investment outcomes are hypothetical in nature, do not reflect actual investment results and are not guarantees of future results. The expectations and other information are for educational and illustrative purposes only. Hypothetical performance has inherent risks and limitations, and prospective investors should not place undue reliance on any such information. Because of Cohen & Steers’ investment focus on real assets, Cohen & Steers will benefit from increased interest in the real asset classes and you should keep this conflict in mind when evaluating the capital market assumptions. Other investments may have characteristics similar or superior to real assets. Additionally, Cohen & Steers may make investment decisions that are inconsistent with the capital markets assumptions or any views expressed herein. Cohen & Steers may also develop and publish material that is independent of, and different than, the capital market assumptions or any views expressed herein.
The intent of the capital markets assumptions is not to predict or project future returns of any investment, asset class or portfolio. Instead, the purpose of the capital markets assumptions is to express Cohen & Steers’ view of expected general asset class returns of the period shown, which may be incorrect, potentially materially so, and are subject to change without notice.
By receiving this communication you agree with and acknowledge the limitations of the capital markets assumptions, the associated conflicts and the restrictions on use described herein.
The information presented is provided as educational, and is not intended to be and should not be relied upon as a recommendation to invest in any specific security or asset class or to adopt any investment strategy or as the primary basis for any investment decisions. Prior to making a decision to invest in any security or asset class, you should consult with your financial professional to determine whether the decision is appropriate for you. Return, yield and volatility expectations are based on Cohen & Steers’ analysis, are not a guarantee of future performance and do not represent the past or projected performance of any fund, an investor, or other account managed by Cohen & Steers.
The assumptions used to form the basis for the information presented are as of the date shown and are subject to change. Projected returns, yield, volatility and liquidity are subject to many factors that are uncertain and outside the control of Cohen & Steers, and analysis which may be subject to error. Projected outcomes depend on economic events, which even if they occur, could result in outcomes that could be materially higher or lower than expected. The performance expectations displayed represent the mid point possible expectations within a broader range of possible outcomes, some of which are negative. Actual outcomes could be materially lower than the central expectations.
An investor cannot invest directly in an index and index performance does not reflect the deduction of any fees, expenses or taxes. Index comparisons have limitations as volatility and other characteristics may differ from a particular investment. There can be no assurance any trends or correlations shown herein would continue in the future.
The information presented is not being provided in a fiduciary capacity and does not account for the age, other investments, financial situation, tax status, investment objectives, investment experience, investment time horizon, liquidity needs and risk tolerance of any investor. We believe the information to be accurate, but we do not represent that it is complete or should be relied upon as the sole source of appropriateness for determining any investment strategy. Cohen & Steers does not provide investment, tax or legal advice and will not advise you on your investment decisions. Investors should consult with their investment, tax or legal professional regarding their individual circumstances prior to making any investment decisions.
Criteria and Methodology
Inputs to these expectations include return, volatility, and correlation across asset classes. Assumptions are generally not updated on a real-time basis, therefore results may vary with each use and over time. All such expectations are subject to change. Yields on all markets are based on levels derived at year-end 2022.
Expectations for returns are driven by a range of factors. Within fixed income, forecasts for interest rates are determined at various maturities based on economic growth, inflation, and policy expectations as well as factors such as the shape of the yield curve, the expected level of real interest rates and inflation breakevens, and credit spreads. These interest rates are used to compute expectations for total returns, accounting for the starting point of bond yields, capital gain/loss based on assumption of benchmark duration, and yield. Treasury bond returns are based on expectations for the level of inflation, the path of future short-term rates, and an expectation for the slope of the yield curve. Credit returns, including corporate, high yield and preferreds are based on expectations of fair value spread levels along with adjustments for historical downgrade and default risk through an economic cycle.
For equities, including listed real assets, various factors contribute to total return expectations. Expectations are based on estimates for earnings growth and fair value multiples. Earnings growth expectations are driven by anticipated profitability and payout ratios, while valuation multiples are based on expected interest rates, risk premiums, and growth rates. Changes in valuations are driven by forecasts of interest rates, risk premiums, growth, and profitability. Dividend yield also contributes to total return.
For commodities, we forecast investable returns on commodity total returns by coming up with expectations on index-level spot returns, roll returns, and collateral returns. Spot returns are a function of inflation and expectations of supply/ demand/inventory balances, roll returns are a function of the typical shape of the commodity futures curve, and collateral returns are a function of our forecast for short term interest rates.
Volatility assumptions are driven by historical experience as well as expectations for changes related to growth, inflation, policy, etc. Volatility for private real estate is adjusted (per academic work by Geltner) to more accurately reflect economic volatility to correct for the autocorrelation/smoothing that exists in private RE returns. Correlations reflect historical correlations.
Forward-looking volatility and correlation assumptions are based on historical outcomes. Volatility data use the full available data history available for each respective market. Correlation data use a common starting point. Future economic and market conditions could result in different experiences in coming years.
Due to the illiquid nature of private real estate, private real estate returns generally exhibit a return pattern that understates the level of volatility that would be realized if assets were valued more frequently. We used a statistical adjustment [Geltner, David. 1993. “Estimating Market Values from Appraised Values Without Assuming”] to adjust for the first-order autocorrelation in the appraisal-based private real estate return series to arrive at an estimate that more accurately reflects the true volatility of private real estate returns for the time periods shown. This adjustment also is applied to calculations of private real estate correlation to other asset classes. Estimates are inherently uncertain and may not reflect actual outcomes. Utilizing different factors or assumptions in conducting the statistical analysis may result in materially different estimates than those shown. Investing in private real estate involves substantial risk, including entire loss of investment.
Certain inputs into the capital market assumptions have been obtained from sources that Cohen & Steers believes to be reliable as of the date presented; however, Cohen & Steers cannot guarantee the accuracy of such content, assure its completeness, or warrant that such information will not be changed. The content herein and inputs into the capital market assumptions are current as of the date of publishment (or such earlier date as referenced herein) and are subject to change without notice. Cohen & Steers does not make any express or implied warranties or representations as to the inputs into the capital market assumptions or the completeness or accuracy of its results.
Risks of investing:
Risks of equity investing. Common stocks are subject to special risks. Although common stocks have historically generated higher average returns than fixed-income securities over the long-term, common stocks also have experienced significantly more volatility in returns. Common stocks may be more susceptible to adverse changes in market value due to issuer specific events or general movements in the equities markets. Common stock prices fluctuate for many reasons, including changes to investors’ perceptions of the financial condition of an issuer or the general condition of the relevant stock market, or the occurrence of political or economic events affecting issuers.
Risks of investing in fixed income securities. Fixed-income securities are subject to the ability of an issuer to make timely principal and interest payments, changes in interest rates, the creditworthiness of the issuer and general market liquidity. In a rising interest-rate environment, bond prices may fall and may result in periods of volatility and increased portfolio redemptions. In a declining interest-rate environment, fixed income securities may generate less income. Longer- term securities may be more sensitive to interest rate changes. High yield securities (“junk bonds”) are lower rated securities that may have a higher degree of credit and liquidity risk. U.S. Treasury securities are backed by the full faith and credit of the U.S. government as to payment of principal and interes.
Risks of investing in real estate securities. The risks of investing in real estate securities are similar to those associated with direct investments in real estate, including falling property values due to increasing vacancies or declining rents resulting from economic, legal, political or technological developments, lack of liquidity, limited diversification and sensitivity to certain economic factors such as interest rate changes and market recessions.
Risks of investing in global infrastructure securities. Infrastructure issuers may be subject to regulation by various governmental authorities and may also be affected by governmental regulation of rates charged to customers, operational or other mishaps, tariffs, and changes in tax laws, regulatory policies, and accounting standards.
Risks of investing in foreign securities. Foreign securities involve special risks, including currency fluctuations, lower liquidity, political and economic uncertainties and differences in accounting standards. Some international securities may represent small- and medium-sized companies, which may be more susceptible to price volatility and may be less liquid than larger companies.
Risks of investing in the energy sector. A downturn in the energy sector of the economy could have a larger impact on a strategy concentrated in the energy sector than on a strategy that does not concentrate in the sector. In addition, there are several specific risks associated with investments in the energy sector, including commodity price risk, depletion risk, supply and demand risk, interest-rate transaction risk, affiliated party risk, limited partner risk and risks of subordinated MLP units. MLPs which invest in the energy industry are highly volatile due to significant fluctuation in the prices of energy commodities as well as political and regulatory developments.
Risks of investing in commodities. An investment in commodity linked derivative instruments may be subject to greater volatility than investments in traditional securities, particularly if the instruments involve leverage. The value of commodity-linked derivative instruments may be affected by changes in overall market movements, commodity index volatility, changes in interest rates, or factors affecting a particular industry or commodity, such as drought, floods, weather, livestock disease, embargoes, tariffs and international economic, political and regulatory developments. The use of derivatives presents risks different from, and possibly greater than, the risks associated with investing directly in traditional securities. Among the risks presented are market risk, credit risk, counterparty risk, leverage risk and liquidity risk. The use of derivatives can lead to losses because of adverse movements in the price or value of the underlying asset, index
or rate, which may be magnified by certain features of the derivatives. No representation or warranty is made as to the efficacy of any particular strategy or fund or the actual returns that may be achieved. Futures trading is volatile, highly leveraged and may be illiquid. Investments in commodity futures contracts and options on commodity futures contracts have a high degree of price variability and are subject to rapid and substantial price changes. Such investments could incur significant losses. There can be no assurance that the options strategy will be successful. The use of options on commodity futures contracts is to enhance risk-adjusted total returns. The use of options, however, may not provide any, or may provide only partial, protection from market declines. The return performance of the commodity futures contracts may not parallel the performance of the commodities or indexes that serve as the basis for the options it buys or sells; this basis risk may reduce overall returns.
Risks of investing in natural resource equities. The market value of securities of natural resource companies may be affected by numerous factors, including events occurring in nature, inflationary pressures and international politics. If a strategy invests significantly in natural resource companies, there is the risk that the strategy will perform poorly during a downturn in the natural resource sector.
Risks of investing in preferred securities. Investing in any market exposes investors to risks. In general, the risks of investing in preferred securities are similar to those of investing in bonds, including credit risk and interest-rate risk. As nearly all preferred securities have issuer call options, call risk and reinvestment risk are also important considerations. In addition, investors face equity-like risks, such as deferral or omission of distributions, subordination to bonds and other more senior debt, and higher corporate governance risks with limited voting rights. Risks associated with preferred securities differ from risks inherent with other investments. In particular, in the event of bankruptcy, a company’s preferred securities are senior to common stock but subordinated to all other types of corporate debt. It is important to note that corporate bonds sit higher in the capital structure than preferred securities and therefore, in the event of bankruptcy, will be senior to the preferred securities. Municipal bonds are issued and backed by state and local governments and their agencies, and the interest from municipal securities is often free from both state and local income taxes. Treasury securities are issued by the U.S. government and are generally considered the safest of all bonds since they are backed by the full faith and credit of the U.S. government as to timely payment of principal and interest. Preferred securities may be rated below-investment- grade or may be unrated. Below-investment-grade securities or equivalent unrated securities generally involve greater volatility of price and risk of loss of income and principal, and may be more susceptible to real or perceived adverse economic and competitive industry conditions than higher-grade securities.
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