Our view as to the outlook for markets has become gradually more positive since the start of the year. In much of developed Europe and particularly in the vital US economy, there has been considerable progress in tackling the inflationary challenge in recent months.
For example, after peaking at 9.1% in June of 2022, US inflation one year later stands at a far-healthier rate of just 3.2%. This has started to give investors – including ourselves – confidence that we may be close to the peak for interest rate rises in key markets.
That is not to say of course, that further challenges may not lie ahead. However, much is already priced in after 18 months of turbulence and as described, there are arguably real signs of economic green shoots in inflation, rates, employment and more.
In turn, this means that our expectations for forward-looking, medium-term market returns, known as Capital Market Assumptions, have improved hugely. CMAs provide expected returns for each of the different global asset classes like UK shares, global shares, bonds and so on. They are calculated with a lot of input from T. Rowe Price, a major US investment firm with whom we have a close relationship, and are mainly based on two things.
One is what is known as the ‘risk-free rate’ – essentially the interest rate you get on cash. That, of course, essentially sets the baseline that all other assets have to beat to attract investors.
The second is very much about what an asset costs relative to the earnings that it generates. So put simply, when asset prices have fallen a lot, as they have recently, that tends to increase the expected future return from that point onward.
And that’s exactly where we are now. For the first time in years, many assets look good value compared to their recent history. Not just shares, but lots of fixed income assets too.
Together, the high risk-free rate and generally modest asset valuations, mean that the current CMAs for the portfolio risk levels over the next five years are the highest we have ever seen them:
It is important to stress that these are the expected average annual returns over the next five years. We do not promise that these are exactly the returns investors will receive in each year – nobody could – as it is likely that returns in some years will be higher and in some years will be lower than these figures. While they are not guaranteed, we believe these figures represent the average annual returns investors in the portfolios can expect – net of investment fees – across the next five years. We just can’t control the sequence.
It should be noted that these high levels are unlikely to last indefinitely. Rates will eventually have to be cut again once economies slow further, which will serve to reduce forward expected returns in line with the mechanism noted above. We believe that in the long-term, interest rates are likely to stabilise at around 2-3%, some way below the current base rate of 5%. So it appears that now is the time to take advantage, although of course returns can never be guaranteed.
The value of pensions and investments can fall as well as rise, and you could get back less than you invested.
Past performance is not an indicator of future performance.
