Despite considerable monetary policy tightening by global central banks over the past 18 months, global economic activity remained resilient, although uneven, through the third quarter of 2023. For Q4 2023, the Multi-Asset team forecasts:
- Annualized nominal 10-year return for Global Equities of 7.8%, an increase from the Q3 2023 forecast of 7.3%. The forecast increase is primarily attributable to more favorable valuations following a -3.3% decline in Global Equities in the third quarter.
- Led by the US, continued resilience in developed economies decreased near-term expectations that central banks would begin easing policy in response to an economic slowdown or further moderation in inflation, driving sovereign interest rates higher. The long-run forecast for hedged Global Aggregate Bonds is therefore 4.9%, compared to 4.2% last quarter.
- The team’s forecast for a balanced portfolio (60% Global Equities unhedged/40% Global Aggregate Bonds hedged) is 7.1% annually over the next 10 years, more than 2% higher than the forecast from the first quarter of 2022, prior to the commencement of the Fed's tightening policy.
Note: Forecasts may not be achieved and are not a guarantee or reliable indicator of future results
Q3 2023 Developments Informing Our Long-Term (10-Year) Forecasts: Global central banks have made significant progress in their fight against inflation, but the higher-for-long stance on interest rates, particularly coming from the US Federal Reserve (Fed), put upward pressure on bond yields during the quarter. After last raising policy rates in July, Chair Powell announced the Fed would proceed by deciding meeting by meeting, putting the Fed in wait-and-see mode to determine the effectiveness of past rate hikes. While core inflation data moved in the right direction over the course of the quarter, it remained elevated and above target, raising concerns among bond investors that rate cuts would get pushed out until later in 2024 and sending yields higher. Political events, including yet another debt ceiling impasse and the ouster of Kevin McCarthy as Speaker of the House of Representatives for trying to resolve it, and Fitch’s downgrade of the US credit rating, also contributed to upward pressure on US yields in recent weeks. Similar to the Fed, the European Central Bank (ECB) last raised rates in September but has since committed to remaining on hold to evaluate the effect of its policy. By contrast, the Bank of Japan (BoJ) has kept rates low and unchanged, although Japanese inflation is finally at above target levels, prompting the BoJ to tweak its yield curve control policy and set the stage to potentially drop the policy altogether in 2024. Our 10-year forecast for Euro-area and Japanese inflation increased modestly compared to last quarter. Higher current bond yields and inflation forecasts have important implications for our long-term asset class forecasts.
Despite considerable monetary tightening by global central banks over the past 18 months, global economic activity remained resilient through the third quarter of 2023. Earlier calls that a recession was imminent have quieted recently as hard economic data in the US have come in stronger than expected, even as soft survey data remained weak. US GDP rose nearly 5% QoQ annualized in Q3, with strong labor demand providing a buffer to household incomes and supporting private consumption, while fiscal stimulus continues to boost the economy. Our 10-year forecast for US GDP growth is modestly higher in this update compared to last quarter. Nevertheless, global activity is uneven, with European GDP contracting modestly in the advance Q3 estimate, driven by the slowdown in the German economy as consumers tighten their purse strings and manufacturers struggle with weak demand and elevated costs. Japan’s economy is a relative bright spot, supported by favorable central bank policy and the weak yen. The economic outlook for China is more mixed, with the government announcing fresh stimulus in an attempt to support the economy while the real estate sector overhang remains a drag. Nevertheless, a number of cross currents still obscure the global economic outlook, and geopolitical risks have increased following the start of the Israel-Hamas war in early October. These events do not have a direct impact on our Capital Market Assumptions but are worth consideration, nonetheless.
Long-Term Global Economic Outlook: We expect real economic growth in developed economies to continue to moderate over the next decade, as it has for the last 30 years. This is due to the limited growth of the developed labor force, which is constrained by domestic demographics. An assumption of no significant offset from improved productivity growth is an additional constraint on growth. Inflation in Developed Markets is also anticipated to moderate over the next 10 years, relative to the elevated rates of inflation observed in 2021 and 2022. Nevertheless, inflation is expected to be somewhat higher than in the period following the Global Financial Crisis (GFC) of 2008 and prior to the COVID-induced recession of 2020. We expect long-run real economic growth and inflation in Emerging Markets to advance at higher annualized rates than in Developed Markets. Younger populations and higher rates of return on capital in Emerging Markets are driving higher rates of nominal economic output compared to Developed Markets. While our baseline long-term inflation expectations assume a reversion to longer-term trends, the nearer-term outlook for inflation is highly uncertain. The four-decade trend in falling US inflation has at least temporarily paused, with US inflation rising to 7.0% in 2021 and 6.5% in 2022. While an extreme scenario of extended 1970s-style, double-digit inflation appears unlikely, the potential for a sustained period of average inflation well above central bank targets, as it still stands today at 3.7%, is a non-trivial risk for investors. We cover these issues at length in two related white papers1 .
Equities: Our 10-year annualized nominal forecast return for Global Equities is 7.8%, an increase from our forecast of 7.3% for the third quarter of 2023. The forecast increase is primarily attributable to more favorable valuations following a -3.3% decline in Global Equities in the third quarter. Our long-term return forecast for US Equities is somewhat lower, at 7.2%. Looking at the rest of the world, Developed Market Equities outside the US are forecast to return 8.9% and Emerging Market Equities are forecast to return 9.5% over the next 10 years. Cheaper valuations, as measured by historical valuation ratios, are driving stronger expected returns for non-US Developed Market Equities versus US Equities. While faster expected economic growth is a positive for Emerging Market Equities versus non-US Developed Market Equities, it is partially offset by relatively less attractive valuations and income growth.
Fixed Income: Global sovereign interest rates moved higher in the third quarter of 2023 as continued resilience in developed economies, led by the US, decreased near-term expectations that central banks would begin easing policy in response to an economic slowdown or further moderation in inflation. Our long-run forecast for hedged Global Aggregate Bonds is 4.9%, somewhat higher than the third quarter 2023 forecast of 4.2%, due to the aforementioned rise in underlying sovereign rates. Our long-run forecast for US Aggregate Bonds is 5.3%, a slightly higher expected return relative to our forecast for Global Aggregate Bonds, attributable to higher initial yields partially offset by a positive contribution from hedging foreign currency exposure. At the end of our 10-year forecast horizon, we expect the Fed’s policy rate to be approximately 3.4%, which is about 200 basis points lower than the midpoint of the policy rate target range at the end of the third quarter of 2023. Outside the US, Developed Market central banks (aside from Japan) are forecast to continue to increase policy rates as inflation pressures remain elevated. In US credit markets, we are forecasting average spreads over the next 10 years will be comparable to those prevailing at the end of the third quarter of 2023, informing expected returns of 5.8% and 6.0% for US Investment Grade (IG) and High Yield Bonds, respectively.
Real Assets: Real Assets are broadly defined to include asset classes that have physical properties or have returns that are highly correlated with inflation. We include Commodities, REITs, and TIPS as Real Assets in our Capital Market Assumptions (CMAs). Our forecasts for all these asset classes are expected to outperform our 10-year US inflation forecast of 2.7%.
Private Assets: Our forecasts for US Buyout Private Equity, US Venture Capital Private Equity, US Mezzanine Private Debt, and Global Private Infrastructure are linked to the forecast outcomes of public market assets with a premium consistent with historical empirical outcomes, acknowledging the underlying illiquidity and potential leverage employed in these asset classes relative to public market counterparts. Our forecasts for Core and Opportunistic US Private Real Estate are based on inputs from the NCREIF Property Indexes and linkages to forecast US economic growth and inflation.
Currency and Currency Hedging Returns: Over the next 10 years, we are forecasting generally negative returns for the US dollar relative to Developed Market peers, with outcomes ranging from an annualized loss of -0.3% for the Australian dollar to a gain of 0.6% for the Swiss franc. Forecast outcomes for Emerging Market currencies range from an expected loss of -2.5% for the South African rand to a gain of 0.7% for the Taiwan dollar. Long-term currency hedging returns against a market-weighted basket of Developed Market exposures are forecast to be net positive for US investors as short-term interest rates are anticipated to be higher over the long term in the US relative to the Eurozone and Japan.
60/40 Portfolio Return2 : Based on our long-term forecasts, a balanced portfolio of 60% Global Equities unhedged and 40% Global Aggregate Bonds hedged is forecast to return 7.1% annually over the next 10 years. This latest forecast is more than 2% higher than our forecast from the first quarter of 2022, prior to the commencement of the Fed's tightening policy. The material increase in our forecast is attributable primarily to the rise in global interest rates over the last two years.
1 Tokat-Acikel, Ahmed, Brundage, Campbell, Cummings, & Rengarajan, 2021, “Is Inflation About to Revive?” PGIM Quantitative Solutions White Paper. https://www.pgimquantitativesolutions.com/research/inflation-about-to-revive
Johnson, Aiolfi, Hall, Patterson, Rengarajan, & Tokat-Acikel, 2022, “Portfolio Implications of a Higher US Inflation Regime” PGIM Quantitative Solutions White Paper. https://www.pgimquantitativesolutions.com/research/portfolio-implications-higher-us-inflation-regime
2 For illustrative purposes only. All model portfolios have significant inherent shortcomings and do not consider many real-world frictions. There is no current PGIM Quantitative Solutions client portfolio with this composition of assets. It does not constitute investment advice and should not be used as the basis for any investment decision.