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What We Learned From Experts' Return Forecasts

Christine Benz discusses her key takeaways from the annual projections issued by several investment firms.

Susan Dziubinski: Hi, I'm Susan Dziubinski for Morningstar. Every year Christine Benz pulls together a compendium of forecasts from the major investment firms for long-term stock and bond returns. She's just published an article on this topic, and she's here today to discuss the key takeaways from it.

Christine, thank you for joining us today.

Christine Benz: Susan, it's great to be here.

Dziubinski: Let's first talk about why these firms put out these forecasts at all, because isn't it really difficult to predict what the market is going to do?

Benz: Well, it is, especially over the short term. But the fact is many of these firms are doing this type of research when managing their own products and portfolios that they run on behalf of clients. And it's also instructive for us individual investors or advisors managing client portfolios to have some expectation of what various asset classes will return. Because that in turn will influence some of the decisions that we make, like, what is our savings rate like, when do we retire. If we have some idea of what the market will return, that helps us figure out how much of the heavy lifting we'll have to do ourselves.

Dziubinski: And then, how do these firms go about even coming up with these forecasts?

Benz: Well, for fixed-income investments, it's usually starting yield is used as the key determinant. And the reason is that as a bond investor, the yield you earn is the main component of your return, and yields have been extraordinarily predictive of what fixed-income assets have earned over time. So, that's the starting point that most firms use when looking at fixed income. In terms of equities, most of these firms use some combination of their expectation of dividend yields, of earnings growth, as well as P/E expansion or contraction, multiple expansion or contraction. Usually, those inputs figure into most of these forecasts.

Dziubinski: So, let's dig into some of the specifics, starting maybe with U.S. equities. The past decade has been terrific. What are the forecasts for the '20s looking like?

Benz: Well, the general overview headline is to temper your expectations for U.S. equities. As you said, Susan, the past decade was tremendous. Where you've got like 13% returns over the past decade, annualized, most firms think we're unlikely to repeat that. And the forecast went from downright gloomy, where I would say Grantham Mayo Van Otterloo sits there as sort of the bearish forecasters, especially for U.S. equities, where they're forecasting a 4.4% real, so inflation-adjusted loss for U.S. equity investors. They do their forecasts over a seven-year horizon. Most other firms weren't quite as pessimistic as that. In fact, I think there was some convergence in kind of the mid-single-digit range for U.S. equities over the next decade. Vanguard interestingly takes a look at different market subcomponents. So, within the U.S. equity market, they are forecasting relatively worse returns for growth stocks--pretty intuitive given how great growth stocks have been--better returns for value, better returns for small caps.

Dziubinski: Interesting. Now, how did these expectations that you've collected this year compare to this time last year?

Benz: Well, I was curious about that. And one interesting takeaway is that there was no clear consensus in terms of whether firms expected to see better or worse returns than they did a year ago. So, a few firms, J.P. Morgan and Vanguard among them, actually said that they had slightly higher forecasts, by no means really optimistic forecasts for U.S. equities, but slightly higher forecasts, because they thought the valuations actually looked a little more attractive. For other firms, especially the very valuation-conscious firms like Research Affiliates and GMO, they actually had pushed their forecasts downward a little bit between 2019 and 2020

Dziubinski: Let's pivot to foreign stocks. Do things look better there than the U.S. stock market, according to these firms?

Benz: Well, here's one spot where there does seem to be some consensus among these firms, where there's overall a widespread expectation that foreign stocks will outperform U.S., not by a lot, but certainly every firm was expecting non-U.S. names to perform better. There's a little bit of a divergence in terms of developed-markets equities versus emerging-markets equities. Again, the valuation-conscious shops really think there's a lot of value in the emerging-markets equity space. Other firms think that developed-markets equities are just as attractive, and I would call out Morningstar Investment Management as a firm that has believed that developed-markets equities, the prospects for them are every bit as attractive as emerging-markets equities.

Dziubinski: And then, what about fixed income? What about bonds?

Benz: Well, here, there were few optimists, where, again, if we're using starting yields as the baseline, yields have come down, and that in turn causes these firms to temper their forecasts for bonds. So, most firms tend to kind of converge in the 2% to 3% range over the next decade. Most acknowledge that, of course, you can pick up a higher return by venturing into lower-quality bonds. But, of course, you have the trade-off of higher volatility with the low-credit-quality products. One interesting theme that I picked up on, though, is that several of these firms took pains to caution people not to abandon bonds despite their meager return prospects. And the key reason is that bonds are shock absorbers for your equity portfolios. I think a few other firms hinted that there could be some sort of equity-market shock sooner rather than later, and you'll be happy that you hung on to fixed-income assets, meager yields and return prospects and all.

Dziubinski: So, what should investors do with these forecasts?

Benz: Well, I think, if you're using any sort of return calculator, you're typically given the option to adjust your return assumption. My thought is that for equity returns, you probably do want to give your return assumption a little bit of a nudge down, maybe be a little closer to, say, the 6% to 7% range, even for like a 25-year time horizon, simply because the next 10 years might not be that good. 

I think there are also implications here, especially for people who are just embarking on retirement where that sequence-of-return risk that we've talked about so often, where you have a market shock early on in your retirement can be so painful to the sustainability of your plan. Make sure that you have laid the groundwork so that you are not having to withdraw from depressed equity assets in case you are an unlucky person who retires into a tough equity market. So, those would be a couple of the key things that I'd be thinking about right now.

The other thing to think about, maybe on a more positive note, is if foreign stocks are set to outperform U.S. and you haven't revisited that asset allocation recently, take a look at that. Maybe nudge a little bit more into the foreign-stock column, or at least readjust, rebalance, because U.S. stocks have outperformed foreign for so long.

Dziubinski: Christine, thank you so much for the perspective and helping us set some realistic expectations.

Benz: Thank you, Susan.

Dziubinski: I'm Susan Dziubinski for Morningstar. Thank you for tuning in.