2020 Long-Term Capital Market Assumptions – Q1 Update

2020 Long-Term Capital Market Assumptions – Q1 Update
An update to our capital market assumptions for Q1 2020.

Invesco Investment Solutions develops capital market assumptions (CMAs) that provide long-term estimates for the behavior of major asset classes globally. The team is dedicated to designing outcome-oriented, multi-asset portfolios that meet the specific goals of investors.

The assumptions, which are based on a 10-year investment time horizon, are intended to guide strategic asset allocations. For each selected asset class, we develop assumptions for expected return, standard deviation of return (volatility) and correlation with other asset classes.

Here we summarize our CMAs for Q1 2020.

Executive summary

The Strategic Perspective: The year ended on a high note, with most assets posting positive returns during the last quarter of the decade. Risk-on sentiment crept through the trade-tension headlines as a phase one agreement came to be, calming market fears. US large cap equities were up significantly in the fourth quarter, bringing calendar-year 2019 returns to the largest one-year gain since 2013! Even Developed non-US equities, a laggard in the expansion, participated in the quarter’s rally. One might think all is rosy in markets, but as strategic investors, we must position ourselves for a less optimistic path. Looking forward, we are constructing portfolios to weather the ups and downs, which is why diversification is central to our investment thesis. Absolute returns will be hard to come by, and for those concerned with risk-adjusted figures, the next 10 years could be challenging. A US or Global 60/401 may not be enough for those seeking nominal returns above 5%. Non-US equities, albeit with more risk, and alternatives, like hedge funds and commodities, are the most attractive long-term CMAs relative to their historical returns (Figure 1). Direct investments in Private Equity and Debt could provide diversification against US overvaluation, expected increases in volatility, and declining yields.

The Tactical View: Over the next few months we expect our leading economic indicators to deteriorate, especially for China and emerging markets due to the coronavirus, “catching-up” with the information currently discounted by asset prices. The impact to Developed markets leading indicators will likely be more modest, but negative nonetheless. Following these developments, we have rotated a portion of our equity exposure from Emerging markets (EM) into Developed markets (DM), resulting in an underweight position to emerging equities versus an overweight to DM both US and non-US. The recent deterioration in the macro environment has also led to a meaningful outperformance in defensive equity factors such as quality and low volatility, which we expect to continue in an environment of increasing risk aversion and downward revisions to growth.

Regional Outlook: 2020’s election cycle, already in full swing, creates strong incentives to avoid escalation in trade tensions by the Trump administration, even as the headroom for further increases in tariffs or widening of their scope without damaging US consumption, employment and US financial markets is likely running out. While the US is easing, there is a real chance that tightening may have been too much too fast, and the inversion in the yield curve was not a fluke. Lack of progress on other fronts like industrial policies and subsidies argue against full risk-seeking asset allocation. A meaningful chance of permanently higher trade and investment barriers between the US and other major economies should be factored into expectations for global growth.

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