2024 Q1 Capital Market Assumptions
Overview
As of early 2024, a US recession doesn’t appear to be in sight, with economic and market resilience pointing to a lower probability of a significant left-tail outcome. However, global economic conditions are uneven, with mixed economic activity in the Eurozone and a disappointing post-COVID rebound in China. Against this backdrop the Multi-Asset team’s forecast includes:
- Annualized nominal 10-year return for Global Equities of 7.1%, a decrease from the forecast of 7.8% for the fourth quarter of 2023. The forecast decrease is primarily attributable to less favorable valuations following an 11.1% advance in Global Equities in the fourth quarter of 2023.
- Global sovereign interest rates moved sharply lower in the final quarter of 2023 as expectations increased that global central banks would begin easing policy in response to moderating inflation and a softening economic outlook. Given the decrease in sovereign rates, the long-run forecast for hedged Global Aggregate Bonds is 3.9%, a full percentage point lower than the prior quarter’s forecast.
- The team’s forecast return for a balanced portfolio of 60% Global Equities unhedged and 40% Global Aggregate Bonds hedged is 6.2% annually over the next 10 years, 0.8% lower than the forecast from the final quarter of 2023, commensurate with declines in both the equity and fixed income forecasts.
Note: Forecasts may not be achieved and are not a guarantee or reliable indicator of future results
Summary
Q4 2023 Developments Informing Our Long-Term (10-Year) Forecasts:
As of early 2024, a US recession does not appear to be in sight. Hard data remains resilient and soft data appears to have bottomed with even the weakest parts of the economy, such as housing and manufacturing, seemingly turning a corner. Economic and market resilience seem to have legs, and our team’s assessment of the probability of a significant left-tail outcome has lessened. However, economic conditions are uneven across the globe. Economic activity in the Eurozone was mixed over the winter, while the strength of the post-COVID rebound in China has disappointed. In contrast, Japan has benefitted from low interest rates, yen depreciation, and post-COVID re-opening.
Bloomberg’s consensus expectations for global GDP growth are moderating slightly for 2024, but global growth is still expected to remain positive, albeit uneven, across regions. The US economy has started 2024 on a solid footing supported by strong labor demand. We see a soft-landing scenario more likely than a recessionary one. Elevated real interest rates and tighter credit conditions will likely weigh on interestrate-sensitive sectors in early 2024 before financial conditions start to ease later in the year following expected rates cuts by the Federal Reserve (Fed). Outside the US, Japanese private consumption will likely be supported by pent-up demand, stronger wage growth, and the government’s new economic stimulus package. Meanwhile, Eurozone economic activity is expected to struggle in early 2024 with a sluggish manufacturing sector. Our 10-year forecasts for GDP growth are somewhat lower among developed economies. While the US growth forecast came down a little more than other developed economies, it remains the standout.
The inflation outlook is relatively consistent across countries, particularly in developed market economies. In the G7 countries, both headline and core inflation spiked higher in the post-COVID period, due in large part to aggressive fiscal and monetary stimulus and steeply rising energy and food costs resulting from Russia’s invasion of Ukraine. The end of 2023 already saw a pullback in inflation attributable to the lagged effect of interest rate hikes on the economy and partly due to base effects. These trends are expected to continue into 2024 as current higher rates continue to weigh on activity. Our 10-year forecast for Euro-area inflation eased compared to last quarter, but developed market inflation forecasts remain elevated compared to recent history. Elevated inflation forecasts have important implications for our long-term asset class forecasts, feeding through into both bond and equity forecasts.
Disinflation gave the Fed and European Central Bank (ECB) room to pause rate hikes in the second half of 2023. During its December meeting, the Fed signaled a base case of three rate cuts during 2024, which was affirmed by Fed Chair Powell in a 60 Minutes interview in early February. Meanwhile, at its January meeting, President Lagarde suggested the ECB will remain on hold until the summer. The possibility of rate cuts sent bond yields significantly lower in Q4 2023, which had a significant impact on our Capital Market Assumptions (CMAs) for bonds as lower starting yields reduced forecasts materially. By contrast, the Bank of Japan (BoJ) is expected to exit its negative interest rate policy in H1 2024. However, the BoJ is likely to act more gradually in order to support the growth recovery.
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, doubledigit inflation appears unlikely, the potential for a sustained period of average inflation well above central bank targets, as it still stands today at 3.1%, 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 7.1%, a decrease from our forecast of 7.8% for the fourth quarter of 2023. The forecast decrease is primarily attributable to less favorable valuations following an 11.1% advance in Global Equities in the fourth quarter of 2023. Our long-term return forecast for US Equities is somewhat lower, at 6.5%. Looking at the rest of the world, Developed Market Equities outside the US are forecast to return 8.3% and Emerging Market Equities are forecast to return 8.9% 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, this effect is partially offset by relatively less attractive valuations and income growth.
Fixed Income: Global sovereign interest rates moved sharply lower in the final quarter of 2023 as expectations increased that global central banks would begin easing policy in response to moderating inflation and a softening economic outlook. Our long-run forecast for hedged Global Aggregate Bonds is 3.9%, a full percentage point lower than our forecast from the prior quarter, due to the aforementioned decline in underlying sovereign rates. Our long-run forecast for US Aggregate Bonds is 4.1%, 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 2023. Outside the US, Developed Market central banks (aside from Japan) are forecast to gradually decrease policy rates as inflation pressures subside and growth remains sluggish. In US credit markets, our forecast for average spreads over the next 10 years is somewhat higher than the spreads prevailing at the end of 2023, informing expected returns of 4.4% and 4.7% 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 CMAs. Our forecasts for these asset classes are expected to outperform our 10-year US inflation forecast of 2.6%.
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 -0.6% for the Australian dollar to a gain of 0.8% for the Swiss franc. Forecast outcomes for Emerging Market currencies range from an expected loss of -2.6% for the South African rand to a gain of 0.8% 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 6.2% annually over the next 10 years. This latest forecast is 0.8% lower than our forecast from the final quarter of 2023, commensurate with declines in both our equity and fixed income forecasts.
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.
