A long-awaited productivity boost from technological innovation warrants renewed optimism for secular growth trends, JP Morgan’s 2018 Long Term Capital Markets Assumptions (LTCMA) report finds.
The latest iteration of the annual JP Morgan report predicts the interplay between cyclical and secular forces, notably demographics and productivity, to influence investment outcomes over the next 10 to 15 years far more than in recent times.
Despite the mature market for global expansion, leaving little scope for any cyclical uplift to average returns, JP Morgan head of global strategy for multi-asset solutions, John Bilton, says there are still reasons for cautious optimism and even some upside risks emerging.
While the steady lowering of potential growth estimates, courtesy of the priced-in ageing population story, has been widely publicised, Bilton says any boost to productivity resulting from a technology upside is yet to reach more conservative economic forecasts.
With technological innovation appearing to have reached a notable turning point that could trigger a long overdue productivity boost, he says there’s more reason to be upbeat on secular growth trends than this year’s estimates of a modest dip in asset returns suggests.
“A continued improvement in the global economy is something investors need to be mindful of,” Bilton says. “But while there are long-term gains to be had, due to the late stage in the cycle, [you need to] be careful of your starting point.”
Based on the pace of development in automation and artificial intelligence (AI), JP Morgan estimates a potential upside risk to baseline growth forecasts of 1.0 per cent to 1.5 per cent, if the promise of today’s innovations becomes fully realised in productivity gains.
To put the magnitude of technological innovation in context, Bilton told Investment Magazine that if just one-tenth of the potential growth accrues annually, it could boost combined GDP in the US, eurozone and Japan by $6.5 trillion by the early 2030s.
Full valuations staunch equity returns
With markets having run so hard, Bilton expects assets to encounter greater valuation headwinds and margin pressure at this late stage of the cycle, compounded by the slow pace of interest rate normalisation.
The 2018 trend GDP growth estimates of 1.5 per cent in developed markets and 4.5 per cent in emerging markets (annualised over 10 to 15 years) are unchanged from last year. However, expected returns for a simple balanced EUR 60/40 portfolio are marginally lower than in last year’s report, at 5.25 per cent, down from 5.50 per cent.
This year’s LTCMA report also concludes that while Alpha opportunities are widely spread across asset classes, equilibrium return expectations remain modest due to the nature of the late-cycle environment.
Other key findings within this year’s report include lower expected equity returns from developed and emerging markets, with the gap between those returns narrowing marginally since last year. “We see returns over our time horizon falling modestly, but steadily behind what historical experience would suggest,” Bilton says.
Better outlook for emerging-market debt and alternatives
As the bright spot in fixed income, credit remains attractive for yield-hungry investors.
Despite the current credit cycle looking somewhat mature, the LTCMA report’s long-term projections of both defaults and recovery suggest current spread levels remain attractive for very long-term investors.
“The [emerging market] debt outlook continues to improve, implying that it offers an attractive diversifier to credit portfolios, even with current spreads quite close to long-term fair value,” Bilton says.
While return estimates reflect the currently compressed level of credit spreads, the report concludes that credit offers an attractive return pickup, relative to government bonds, with US investment grade and high yield offering returns of 3.50 per cent and 5.25 per cent, respectively.
With industry and investment trends favouring alpha generation, the LTCMA report projects an improving outlook for alternative strategies, relative to public markets; however, Bilton reminds investors that manager selection is critical to investment success across all alternative strategy classes.
Active asset allocation and diversification
Despite more modest outlooks in many asset markets, Bilton reminds investors there are ample opportunities to boost returns through active asset allocation and diversification. To successfully ride out near-term cyclical challenges, Bilton says, alternative sources of risk premia, and careful manager selection, are essential tools for investors, who need to construct robust and versatile portfolios.
“There are multiple ways of bringing risk [premia] into the portfolio, and 60/40 returns just aren’t going to do it for you,” Bilton says. “As there’s more to play for now, careful manager selection is all about bringing different sources of risk premia into the opportunity set.”
Bilton says another important consideration for investors is the impact of currency translation on asset returns. While the US dollar remains meaningfully above long-term estimates of fair value, despite sharp declines in 2017, the LTCMA report predicts that the pace of further declines will moderate somewhat.