Smarter portfolios for a world in transition

Slightly higher growth and inflation

Building long-term outlooks begins, as always, with a macroeconomic perspective.

This year’s LTCMAs consider the impact of multiple transitions, across the economy, policy, technology and energy. These transitions will likely have varying effects on global growth and inflation, at different times and in different regions and sectors.

We see a positive impact on growth from the technology transition. While the timing and magnitude is uncertain, we expect that AI will help increase productivity, which could boost GDP. Improved labor force growth in the United States and increased investment in the energy transition in Europe could also support growth.

On balance the LTCMA  global growth assumption rises slightly, to 2.4%.

Higher inflation is expected. For example, in the United States, euro area and United Kingdom, the LTCMAs anticipate a 2.4% rate over the next 10 to15 years, well above the pace of the 2010s.

Stronger wage growth helps boost inflation assumptions from 1.8% to 2.2% in the euro area and from 0.9% to 1.4% in Japan (where any inflation at all had long seemed an improbable prospect). The LTCMA U.S. inflation assumption falls slightly, from 2.6% to 2.5%.

Potential for higher bond returns, lower equity returns

High policy rates support the LTCMA fixed income assumptions: The USD cash assumption rises 50bps, to 2.9%, and the Global Aggregate bond assumption jumps 40bps, to 5.1%.  

Following the reset in yields, real bond returns could be robust across the fixed income complex. Critically, we believe investors can again rely on bonds both for income and diversification from disinflationary growth shocks.

The LTCMA expected equity returns fall in the wake of the 2023 rally, but not as far as might be expected. That’s partly because the outlook anticipates that corporate profit margins will be higher than the historical average. The view reflects the increased market value of particularly profitable, high return on capital companies (many in the tech sector).

Even so, the LTCMA outlook for global equities dips 70bps, to 7.8%—still a solid potential return. In addition, in the LTCMAs, the gap between developed market and emerging market equity returns narrows this year.

U.S. large cap return expectations decline from 7.9% to 7.0%, reflecting higher valuations. The LTCMAs see an attractive outlook for non-U.S. developed markets. Profit margins will be supported by various factors, the outlook suggests: in Europe, a sectoral shift to more profitable and higher return on asset sectors; productivity enhancements, including the increasing adoption of AI; and pricing that does not revert fully to pre-pandemic levels.

By contrast, the LTCMA assumptions for emerging market equity have moderated. Investors are increasingly skeptical about the outlook for Chinese equities and unwilling to pay high multiples. However, because Chinese stocks did not participate in the 2023 rally, a lower starting point supports expected returns.

Alternative assets: Inflation resilience, potential for stronger returns

Alternative assets are arguably the brightest spot in the LTCMA return outlook this year. (We again note that investing in alternatives often involves a greater degree of risk than investing in traditional assets.)

The case for investing in private markets comes from the inflation resilience that alternatives have demonstrated as well as from improving returns.

The inflation-hedging benefits of real assets (including infrastructure, real estate, transport and timber) could prove especially useful over the LTCMA investment horizon. The projected return for global infrastructure (core), which could get a boost from the ongoing energy transition, rises from 6.3% to 6.8%.

Despite some well-flagged issues in some segments of U.S. commercial real estate and persistent weakness in China, we believe that the outlook for core real estate is strong. (For example, the U.S. core real estate expected return rises from 5.7% to 7.5%).

The LTCMA projected returns for financial alternatives are more mixed—they rise sharply for venture capital and direct lending and fall modestly for private equity (following equity market returns lower) and hedge funds. 

Across all alternative sectors and strategies, future performance may exhibit wider dispersion of returns, depending on the individual manager. That dispersion underscores the importance of manager selection when investing in alternatives.

Currency: A new path to dollar decline

In our view, the U.S. dollar (USD) remains overvalued and looks set to decline against most other currencies over a 10- to 15-year investment horizon. However, over the longer term, we think that shifts in capital flows, rather than pure interest rate and economic growth differentials, will dictate the path of currencies.

Here, we focus in particular on the eurozone and Japan. The two regions struggled through a long stretch of stark underperformance in nominal growth, interest rates and equity markets. That period looks to have ended. As capital flows shift back toward the eurozone and Japan, their currencies will likely strengthen and compound the dollar decline.

The prospect of a new path to dollar decline may be of particular interest to our many clients whose portfolios are overweight USD and U.S. assets. Currency-hedging strategies are designed to help mitigate foreign exchange risk and may offer the potential for both portfolio returns and diversification.

Meeting the diversification challenge

Clearly portfolio diversification will be a persistent challenge as the economic environment moves through a state of transition. (Hiding out in cash may be tempting, but remember that cash has historically underperformed over the long term.)

Owning both stocks and bonds is a first principle of portfolio diversification—but it’s just a start. That’s because bonds do a good job of hedging  portfolios of riskier assets (for example, stocks and high yield credit) against economic growth shocks, but a subpar job hedging them against inflation shocks. Investors learned this lesson the hard way in 2022, when stocks and bonds both posted year-end losses for the first time since 1974.

One year ago, the LTCMA message focused largely on the jump in expected returns for the core set of public market assets. This year, it is more about the breadth of opportunity available across the wider asset markets. When inflation risk is two-way and stock-bond correlation is no longer reliably negative, investors will need to explore different kinds of diversification to hedge portfolios and boost potential returns.

We can help

J.P. Morgan Asset Management’s Long-Term Capital Market Assumptions find that markets today may offer the potential for solid returns across asset classes and new opportunities for portfolio diversification. It’s a good time to build or revisit your wealth plan to help ensure you are on track. Reach out to your J.P. Morgan team.