MARKET VIEWS

2020 Long-Term Capital Market Assumptions – Q3 update

2020 Long-Term Capital Market Assumptions – Q2 Update
Invesco Investment Solutions (IIS) is dedicated to designing outcome-oriented, multi-asset portfolios that meet the specific goals of investors. Capital market assumptions (CMAs) are key to this effort.

The team develops CMAs that provide long-term estimates for the behavior of 160 major asset classes in 19 different currencies, including 7 private asset classes. Due to the pandemic, this quarter’s special edition includes manual adjustments to our CMAs based on prior recessions, resulting in three distinct investment scenarios; Bull, Base, and Bear.

Here we summarize our CMAs for Q3 2020. For the full report, download it here

Asset allocation insights: Strategic perspective
By Duy Ngyuen (CIO, IIS) and Jacob Borbidge (Senior Portfolio Manager, Head of Investment Research, IIS)

It is difficult to imagine that only three months ago we were writing about riding out the first global recession, record levels of unemployment and declines in earnings not seen during any of our lifetimes. While it may have felt like the last quarter lasted much longer than a quarter, with us all stuck at home with limited distractions, it is still remarkable 

to take stock of what has changed during that short time period. Record unemployment and potential demand destruction has been whitewashed over by an avalanche of fiscal stimulus. Concerns over markets locking up due to liquidity demands have largely been alleviated through loosening monetary policy and direct intervention in markets that needed it most. Lastly, let’s not forget the support to main street via financing and other aid to businesses, troubled or not, helping them to weather the storm and be ready to reopen when conditions allowed. Taken in isolation, someone looking at those factors could easily see how markets could have recovered the way they have this quarter, but it was certainly not evident to most at the time. Add to that the level of technological innovation many of us have witnessed during this time period, with working from home and near-instant delivery of goods now options for many individuals, and some of today’s lofty asset prices start to make sense; historic loss followed by historic rebound, supported by quick policy action and further hopes of innovation on the medical front. 

The confounding detail that is at odds with this recovery, of course, is COVID-19 and its continuing impact on the world. At this time, we are still seeing the virus rapidly spread in many regions along with resurgence and reclosure in areas where there was thought to be containment. For the most part, the COVID charts we’ve been following are all still pointing up. In alphabetical terms, we would classify the recovery in the market and economy as squarely in the “V” territory, while the virus is still looking like a “U” (inverted) or maybe a cursive “W” if we want to get creative. 

Amid this uncertainty we are privileged to share our 3Q 2020 Capital Markets Assumptions with our clients and colleagues. From the Solutions Team’s strategic perspective on asset allocation, we remain in our Base case scenario introduced last quarter and we feel the market has largely priced in a picture-perfect COVID and economic recovery, with the worst largely behind us. In the short-term, given the level of stimulus from around the globe, this may be broadly within reach. Even if that proves to be the case, the multi-trillion-dollar bill for this stimulus will eventually come due, and we expect there will be winners and losers along the way, precisely the reason for our long-term look on a broad set of assets globally.

Three hypothetical scenarios for how the pandemic may unfold – we remain in the Base case
image 1
Source: For illustrative purposes only.

CMA observations:

Not unlike how we started the year, two long quarters ago, investors are faced with low returns, full valuations and political uncertainty. A global 60/401 portfolio has seen its expected 10-year returns fall by almost 1% year-to-date, to 3.7% annualized, and worse 

is expected for its US counterpart. This is the lowest expected return since we started tracking the data in early 2000. Both equity and fixed income assets are likely to experience headwinds over the coming decade which makes the job of an investor increasingly challenging. As such, Alternatives like Hedge Funds, Commodities, and Private Market assets are increasingly finding their way into discussions to help achieve return targets and diversify risks. 

Nearly all Developed Market equities saw a decrease in return assumptions quarter-over-quarter, lead by higher valuations and lower yields. Growth expectations recovered somewhat as we look past the damage done over the past few quarters and forward to a recovery. Our expectations around return to peak earnings are still in the U-shaped recovery camp. The base case scenario captured most of the downward revisions to earnings and we expect they will return to peak in late ’21 or early ’22.

Emerging Market equities return assumptions are broadly higher, largely driven by a quicker return to growth than previously modeled, especially in economies with ties to China. Valuations moved up with higher growth expectations but are still close to fair value and not overly expensive. Yields also appear to have stabilized.

Within Fixed Income, the largest quarter-over-quarter decreases in return expectation were centered on spread-sensitive assets such as corporate bonds, emerging market bonds and bank loans. Default probabilities remain above their long-term average. High yield bonds, specifically, saw the largest decrease in return expectations after a swift recovery and tightening spreads in the second quarter. Hong Kong Dollar bonds and US Long Treasuries were some of the few other assets that saw an increase in returns, given a slightly steepening curve.

Download the full report.

^1 Global 60/40 represented by 60% MSCI ACWI Index and 40% BBG BARC Global Aggregate Bond Index.