JP Morgan: Prepare for Lower Investment Returns

JP Morgan's Leon Goldfeld says both equities and bonds will deliver lower returns to investors over the next decade but inflation will also be muted

Emma Wall 8 November, 2018 | 2:08PM



Emma Wall: Hello and welcome to the Morningstar series, "Why Should I Invest With You?" I'm Emma Wall and I'm joined today by JP Morgan's Leon Goldfeld.

Hi, Leon.

Leon Goldfeld: Hi, Emma.

Wall: So, we're here today to talk about the importance of thinking long-term, constructing portfolios and what exactly is risk. There has been a lot of volatility in markets over the last couple of months, but increasingly our readers and I'm sure your investors tell you that they are investing for the long-term. So, looking long-term where are you thinking in terms of the cycle and opportunities?

Goldfeld: So, for our investors, the way we manage money, we do take very much a longer term perspective. We manage over $250 billion of assets for clients and in order to position those assets correctly, we need to have that angle, as to where are the markets going, not just today or next week or next month, but actually not over the next 5 years to 10 years, 15 years. And we have an exercise that we do annually and we've been doing it for 23 years, which we call the long-term capital market assumptions, which is a bit of a mouthful.

But in essence what it means is we try to project out 10 years to 15 years, where we think economic activity is going to be, what sort of growth economies are going to generate, where policy is likely to go, how far will rates rise over the cycle and where they're going to stabilise? And most importantly, what does that mean for equity market returns, fixed income market return and currency market returns? And every year, we devote a lot of resource, more than 30 of our strategists, economists, portfolio managers are involved in this exercise, in order to really make sure that we hone our views correctly. And we've been doing it, as I said, for 23 years. We have a track record that actually is quite strong in terms of not necessarily pure accuracy of the forecast, but stability of them and actually the value they bring to clients.

So, what does it all mean looking out to 10 years from today? Our view is that we're in a world where growth is likely to be fairly moderate for the next 10 years. So, investor expectations about returns, which have been very strong when we look back over the last 10 years, since the crisis. But even over the last 25 years, we think returns over the next 10 years are going to be shallower than they've been over the last 10 years and that's largely a function of two things. One; the absolute level of growth in economies is going to be slower than it has been, reason for that is that productivity is generally on a slowing trend. And more over demographics, which means ageing of population, aging of the workforce has also slowed. So, those two factors basically mean that growth has moderated from the past where it's likely to be in the future.

The second factor that actually cautions somewhat the absolute level of returns that investors should expect, particularly in risky markets like equities or for that matter alternatives and credit is the fact that we are starting today towards what we would say the end of the cycle. We have been growing very strongly since the financial crisis, so we've had almost a record length of growth if we use the U.S. economy as that kind of a barometer. The sort of gap between the past recession and potential future recession, this growth period has been one of the longest one on record. And we think it's going to continue probably for the next couple of years as well before we really run into recession.

But the fact that we're starting at the end of the cycle has a couple of implications. One, we're starting from a point of elevated valuations. It doesn't mean the market valuations will change tomorrow, but over the next 10 years, we would expect valuations to gradually decline. So, P/E levels will probably drop from where they are today and as that happens, essentially that's a headwind to returns because you are getting a lower price for the earnings that you are generating.

The other factor that also kind of influence us to be somewhat more cautious into the future is that when we look at corporate earnings margins, so what profitability companies are generating, they're fantastic today, and it's great that they're fantastic today. But that's not necessarily sustainable into the future. It is traditional end of cycle, when our companies can generate the best profits over the cycles usually at the end.

Wall: Now, of course, we are talking multi-asset here. Those two measurements that you just described are typically of equities. Should we expect lower returns from bonds and alternatives as well? Is this going to be 10 years of just suppressed returns across asset classes?

Goldfeld: So, we generally are looking for lower returns than in the past, across all asset classes, but there are nuances. For alternatives, which actually tend to be they are a wide band from real estate, infrastructure, private equity, commodities alternatives, is not a homogeneous asset class. But generally, we would expect those asset classes to still be influenced by the fact that we have slower economic growth and we're also starting from a point in a cycle that's not necessarily the most favorable So, their returns will also likely to be diminished.

In a case of bonds, we've generally been in a low, obviously, interest rate world. The Fed is the only central bank that's actually managed to read off – the major central banks have managed to lift rates and they will we think continue to lift rates. So, bond returns actually over the last 10 years have been influenced by the fact the bond yields have come down and bond prices have gone up. And so that actually has accentuated, the returns that people have got from bonds and what they've been used to.

We think going forward, particularly, if we look at European bonds, U.S. bonds, likely – more likely than not, you're just going to get running yields. And the running yield that you're going to get today, let's say, if we're looking at U.S. bonds, is somewhere around 3%. That's probably less than you got historically, but actually it's not bad because we do you think one of the features going forward is we're going to be in a lower inflation world. So, in real terms, which is actually what matters for wealth, real growth, real returns, it won't be bad. But in absolute nominal terms, I think investors have to get used to slightly lower numbers.

Wall: Leon, thank you very much.

Goldfeld: Thank you, Emma.


Wall: This is Emma Wall for Morningstar. Thank you for watching.

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Emma Wall

Emma Wall  is Senior International Editor for Morningstar

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