Capital Market Expectations

Capital Market Expectations

Return expectations are an important element in determining how we optimize our portfolios. In addition, they help us estimate what to expect from our portfolios over the longer term. Since markets are driven by emotions in the short term, we do not try to guess where they’ll end in the coming year. In fact, research has shown that the statistics used to make these predictions have no near-term predictive power. So, we think making investment decisions on those guesses is a mistake. Over the longer-term, however, average returns, reversion to the mean for overpriced and underpriced assets, and long-term trends do have predictive power. Therefore, our forecasts are based on 10 year expectations.

Before getting into the numbers, a little preface is needed to give some insight as to the thinking behind these estimates. Over the long term we expect global economic growth to continue to be positive. The world population is growing and more and more economies are enjoying the benefits of liberal economic policies. Consequently, the middle class is growing around the world and people have more disposable income. We expect positive growth to occur in the United States as well; however, we do not expect the US to achieve the kind of growth enjoyed after World War II. For many years, the US economy provided the resources that rebuilt the world. Now, the rebuilding is over and economies around the globe are less reliant on the US. Our economy has matured. So instead of 4% growth, we think long term US growth of 2% is more realistic. Central banks around the globe have become much more involved in keeping economies and markets moving in a positive direction, and we believe this will continue. As a result, we expect monetary policy to be more accommodative than historic norms. While these policies create inflationary pressures, we think inflation will remain subdued due to the aging population in many areas around the globe.

Although central bank intervention has helped equity markets become less volatile over the last 10 years, we expect volatility to move higher but remain below historic averages. Also affected by central bank policies is the correlation of asset classes. The relationship in the movement of asset prices has trended higher because of the freer flow of capital around the globe and the better dissemination of information, along with central bank policies. We expect this increased interdependence of asset classes to continue. Consequently, diversification via traditional asset classes will be less effective, resulting in elevated portfolio volatility.

Within this environment, over the next ten years, we expect domestic equities to provide an average annual return of 6.5%. With the economy growing below its average since World War II and current stock values above historic norms, we think expectations above this would be optimistic. For comparison, the 50 year annualized return on domestic stocks has been 10.2%. However, the return over the last 20 years has only been 5.6% per year. We expect foreign developed equities to provide an annualized return of 5.7%, given the slower growth in many foreign economies and the increased risks. We anticipate real estate and global infrastructure to grow at an average annual rate of 5.7%, somewhat below our expectations for stocks.

There is an adverse effect on prices when the US dollar is strong because commodities are generally priced in US dollars around the globe. Since we expect the US economy to continue to grow at a rate above that of the rest of the developed world, we expect the strength of the dollar to be a headwind on commodity prices. In addition, the overall slowing of the global economy will provide pricing pressure. As a result, we expect commodities to grow an annualized rate of close to 4%. For high quality bonds, with little inflationary pressure, we expect returns to average 3.4%. This is below the 20 year average of 4.5%, but reasonable given how low current interest rates are.

Our risk management strategies provided the cushions we had expected during the market’s decline in the 4th quarter of 2018. During that period, both equity and bond prices deteriorated due to the hike in interest rates; however, these strategies moved independently and generated positive returns overall during the market’s biggest swoon in December. As a group we expect these strategies to provide bond like returns of 3.4% annualized over the next 10 years.

So overall, given the current price of the markets and the expected economic growth here and abroad, we expect portfolio returns to fall below their 50 year averages but to be in line with the average returns achieved over the last 20 years.


Washington Trust Bank believes that the information used in this study was obtained from reliable sources, but we do not guarantee its accuracy. Neither the information nor any opinion expressed constitutes a solicitation for business or a recommendation of the purchase or sale of securities or commodities.

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Washington Trust Bank.