WEBVTT 1 00:00:00.392 --> 00:00:04.534 You're listening to Strictly Business Podcast with Lindsay Williams. 2 00:00:05.415 --> 00:00:11.158 I received a piece of work entitled Capital Markets Assumptions, A New 3 00:00:11.158 --> 00:00:13.158 Investment Reality Takes Shape. 4 00:00:13.158 --> 00:00:15.901 It came from the desk of Daniel Morgan, multi-asset analyst at 91. 5 00:00:16.461 --> 00:00:22.764 And Daniel collated data up to the 31st of March of 2025. 6 00:00:22.784 --> 00:00:29.028 The piece was published on May the 6th, 2025, and immediately alarm bells started 7 00:00:29.028 --> 00:00:31.028 ringing. 8 00:00:31.028 --> 00:00:31.529 in my mind, because in the piece, 9 00:00:31.869 --> 00:00:36.431 Daniel assessed the long-term expected returns across global asset classes. 10 00:00:36.771 --> 00:00:40.733 And the latest edition of CMA, based on data, as I said, at the end of March, 11 00:00:41.073 --> 00:00:45.615 showed a modest uplift in expected returns across both equities and fixed income. 12 00:00:45.775 --> 00:00:49.816 But it didn't take into account, of course, tariffs, which means, in a sense, 13 00:00:50.056 --> 00:00:52.838 it was out of date the moment it hit people's desks. 14 00:00:53.198 --> 00:00:54.738 Let's sort of qualify that now. 15 00:00:54.818 --> 00:00:56.099 Daniel is with me. 16 00:00:56.459 --> 00:00:58.580 Daniel, tricky times to write reports. 17 00:00:59.752 --> 00:01:06.677 Well, I mean, I think the nice thing about the work that we do that leads into these 18 00:01:06.677 --> 00:01:08.677 capital market assumptions is that 19 00:01:08.677 --> 00:01:14.083 it actually gives us that chance to sort of take a step back from some of the 20 00:01:14.083 --> 00:01:16.083 excitement and the noise that we sort of see day to day 21 00:01:16.083 --> 00:01:17.546 and think about the long term outlook for financial markets. 22 00:01:17.826 --> 00:01:21.309 So we're trying to think about returns on a 10 year horizon. 23 00:01:21.829 --> 00:01:25.332 And clearly one one very important factor there is. 24 00:01:25.888 --> 00:01:32.871 valuation is the price you pay when you get into the market so the volatility that 25 00:01:32.871 --> 00:01:34.871 we've seen uh clearly has an impact i mean actually as 26 00:01:34.871 --> 00:01:39.734 we sit here today in sort of mid-may we kind of struck this work based on market 27 00:01:39.734 --> 00:01:41.734 levels at the end 28 00:01:41.734 --> 00:01:45.216 of march 31st of march okay free free the latest round of tariff excitement and 29 00:01:45.216 --> 00:01:45.536 actually 30 00:01:45.536 --> 00:01:52.179 we've sort of had a big round trip so so in terms of where we are today we're sort 31 00:01:52.179 --> 00:01:54.179 of back to roughly the levels we were at on the 32 00:01:54.179 --> 00:01:55.492 31st of march where this this work is dated. 33 00:01:55.893 --> 00:02:01.835 Now, things will change again, but, you know, as we sit here today, I think we're 34 00:02:01.835 --> 00:02:03.835 sort of actually in the same spot as we were at the end of March. 35 00:02:03.835 --> 00:02:08.818 So you could have gone away when you first collated all this data and wrote this 36 00:02:08.818 --> 00:02:10.818 report, gone away for six weeks with no cell phone, come back today, 37 00:02:10.818 --> 00:02:12.818 and absolutely nothing has changed. 38 00:02:12.818 --> 00:02:13.920 Well, obviously, that's a little bit of an exaggeration, but I get your point. 39 00:02:14.180 --> 00:02:18.682 You made a case study, and you say, rethinking US exceptionalism and European 40 00:02:18.682 --> 00:02:20.682 renaissance. 41 00:02:20.682 --> 00:02:22.864 During that period, US exceptionalism was being doubted, very much so. 42 00:02:23.384 --> 00:02:26.166 but European Renaissance was very much a theme. 43 00:02:26.667 --> 00:02:28.889 Is it going back to the other extreme now? 44 00:02:29.189 --> 00:02:30.690 In other words, as I said, Mr. 45 00:02:30.750 --> 00:02:33.813 Trump suddenly having this resurgence of confidence. 46 00:02:34.894 --> 00:02:37.936 Yeah, I mean, I think when we sort of thought about the subject of 47 00:02:38.717 --> 00:02:42.200 US exceptionalism that's clearly been at the front of everyone's minds, 48 00:02:42.360 --> 00:02:47.044 we sort of tried to take a step back and put sort of things in a historical 49 00:02:47.044 --> 00:02:49.044 perspective. 50 00:02:49.044 --> 00:02:52.008 I think that's kind of one of the things that we can do through this work is take 51 00:02:52.008 --> 00:02:54.008 that sort of... 52 00:02:54.008 --> 00:02:56.742 longer view, be more data-driven, more analytical in that sense. 53 00:02:57.222 --> 00:03:04.025 And I guess we kind of looked at the 10-year period up to the end of 2024 as 54 00:03:04.025 --> 00:03:06.025 being kind of the high 55 00:03:06.025 --> 00:03:08.025 point of US exceptionalism, I guess. 56 00:03:08.025 --> 00:03:09.187 And that term probably means different things to different people. 57 00:03:09.727 --> 00:03:16.350 But one of the ways that it was most clearly expressed in markets was this 58 00:03:16.350 --> 00:03:18.350 incredible outperformance of US equities over that decade. 59 00:03:18.350 --> 00:03:21.032 So I think for the 10 year period to the end of 2024. 60 00:03:21.660 --> 00:03:27.603 US equities returned 13% per annum, which was basically double the return of the 61 00:03:27.603 --> 00:03:29.603 next best region. 62 00:03:29.603 --> 00:03:30.725 So Europe and Japan returned around 6.5% in dollars. 63 00:03:31.085 --> 00:03:36.808 And it was about three times the return of the UK and emerging markets over that time 64 00:03:36.808 --> 00:03:36.888 horizon. 65 00:03:37.088 --> 00:03:39.049 Really, really dramatic outperformance. 66 00:03:39.069 --> 00:03:42.011 And I guess the question then is where we go from here. 67 00:03:42.091 --> 00:03:44.672 So yes, that's clearly the next part to think about. 68 00:03:45.000 --> 00:03:49.062 So read US exceptionalism and read equity outperformance. 69 00:03:49.063 --> 00:03:53.804 And that has been challenged, of course, and it was challenged quite spectacularly, 70 00:03:53.804 --> 00:03:55.804 but very, very briefly as well. 71 00:03:55.804 --> 00:03:58.065 And I think with the performance on May the 12th, I think it was, 72 00:03:58.525 --> 00:04:05.288 the markets clawed back everything and in fact rose above the Liberation Day 73 00:04:05.288 --> 00:04:07.288 sell-off or the days 74 00:04:07.288 --> 00:04:08.550 after the Liberation Day speech, that famous or infamous one. 75 00:04:09.070 --> 00:04:14.452 You say that the dynamics may be changing in Europe and it could be nearing a... 76 00:04:14.772 --> 00:04:15.493 turning point? 77 00:04:15.533 --> 00:04:21.417 Is it because of the demise of US exceptionalism, albeit brief, or is there 78 00:04:21.417 --> 00:04:23.417 other factors to play here? 79 00:04:23.417 --> 00:04:26.640 I mean, I think related to the broader global environment, global changes, 80 00:04:26.660 --> 00:04:32.684 but I think the positive case for Europe actually depends more on domestic factors 81 00:04:32.684 --> 00:04:34.684 than on, 82 00:04:34.684 --> 00:04:35.446 you know, sort of negatives elsewhere, I think. 83 00:04:35.966 --> 00:04:40.630 And I mean, again, sort of taking the the longer outside view of this. 84 00:04:41.690 --> 00:04:42.931 Europe has been through... 85 00:04:44.252 --> 00:04:51.060 a sort of prolonged period of kind of stagnation at least in terms of uh 86 00:04:51.060 --> 00:04:53.060 corporate profits and corporate revenue so you know it 87 00:04:53.060 --> 00:04:57.468 basically took until this year for uh the dividends paid by european companies to 88 00:04:57.469 --> 00:05:03.983 um sort of move above the peak that they hit prior to the gfc so you know, what is 89 00:05:03.983 --> 00:05:05.983 that now, 17 years ago, 90 00:05:05.983 --> 00:05:11.289 a 17-year period of no growth essentially in the level of income paid out by 91 00:05:11.289 --> 00:05:13.289 European corporates. 92 00:05:13.289 --> 00:05:15.172 And so that's kind of a pretty spectacular outcome historically. 93 00:05:15.853 --> 00:05:22.638 And it seems that the reasons for that were, you know, dealing with the legacies 94 00:05:22.638 --> 00:05:24.638 of the GFC. 95 00:05:24.638 --> 00:05:30.365 And if we think that actually most of those issues in terms of the debt 96 00:05:30.365 --> 00:05:32.365 overhang, for example, are sort of working their way out of the system. 97 00:05:32.365 --> 00:05:34.365 And we look to a world where 98 00:05:34.365 --> 00:05:40.398 European governments have decided to sort of break with austerity and the sort of 99 00:05:40.398 --> 00:05:40.618 fiscal 100 00:05:40.758 --> 00:05:43.980 rules that they'd imposed on themselves and invest more for the future, 101 00:05:44.000 --> 00:05:50.804 which is probably one of the sort of the key imbalances or weaknesses in the 102 00:05:50.804 --> 00:05:52.804 European economic setup in recent 103 00:05:52.804 --> 00:05:54.804 years. 104 00:05:54.804 --> 00:05:57.327 I think it seems reasonable as a sort of starting point to think that actually, you 105 00:05:57.327 --> 00:05:59.327 know, after a period of stagnation, 106 00:05:59.327 --> 00:06:00.189 we can return to levels of growth that we saw. 107 00:06:01.954 --> 00:06:05.916 more similar to the levels of growth we saw historically in the decades leading up 108 00:06:05.916 --> 00:06:07.916 to the GFC. 109 00:06:07.916 --> 00:06:10.459 So there were some unsustainable aspects to that in the boom years. 110 00:06:10.499 --> 00:06:17.344 But on a longer term view, steady growth in corporate profitability in Europe was a 111 00:06:17.344 --> 00:06:19.344 factor for many decades. 112 00:06:19.344 --> 00:06:24.449 And I think there's a reasonable case to be made that we're going back to that kind 113 00:06:24.449 --> 00:06:26.449 of world after a very difficult period. 114 00:06:26.449 --> 00:06:27.791 Yes, and is this a pan-European movement or is it in spots? 115 00:06:27.831 --> 00:06:31.013 In other words, is Spain doing something correct and Germany not? 116 00:06:33.015 --> 00:06:38.719 I mean, I think certainly when we're trying to take a longer sort of forecast 117 00:06:38.719 --> 00:06:40.719 horizon here, 118 00:06:40.719 --> 00:06:45.103 we have to try and think more in terms of broader markets and broader sort of 119 00:06:45.103 --> 00:06:45.164 regional 120 00:06:46.264 --> 00:06:46.964 views. 121 00:06:47.405 --> 00:06:53.469 It's just the more, the narrower you get, the more sort of you're exposed to just, 122 00:06:53.469 --> 00:06:53.589 you know, 123 00:06:54.053 --> 00:06:57.275 individual things happening that you didn't expect in individual markets. 124 00:06:57.675 --> 00:07:01.417 So at least at the level of kind of the capital market assumptions work, 125 00:07:01.838 --> 00:07:05.680 we're taking kind of an overall view on the European economy, I guess, 126 00:07:06.120 --> 00:07:11.083 rather than on the specifics in any individual country or sector. 127 00:07:11.644 --> 00:07:14.525 Okay, let's have a look at some asset classes now and start with fixed income. 128 00:07:15.126 --> 00:07:19.088 Income continuing to drive the bulk of return potential, you say. 129 00:07:19.148 --> 00:07:20.609 Could you expand upon that, please? 130 00:07:22.053 --> 00:07:28.037 Yes, so I mean, I think if we think about sort of government bonds in developed 131 00:07:28.037 --> 00:07:30.037 markets as a starting point, 132 00:07:30.037 --> 00:07:33.059 we have seen a big reset in yields in recent years. 133 00:07:33.060 --> 00:07:39.883 So we're now, we have a global interest rate structure, which looks more like the 134 00:07:39.883 --> 00:07:41.883 kind of the prevailing environment in the 135 00:07:41.883 --> 00:07:46.907 2000s. So having come out of this world of zero and even negative policy rates and 136 00:07:46.907 --> 00:07:48.907 interest rates 137 00:07:48.907 --> 00:07:49.349 in quite a lot of developed markets. 138 00:07:49.745 --> 00:07:55.628 We've now shifted into a place where it seems like sort of through the cycle 139 00:07:55.628 --> 00:07:57.628 interest rates, 140 00:07:57.628 --> 00:08:01.011 neutral interest rates in developed markets are resetting at a more positive 141 00:08:01.011 --> 00:08:03.011 level. 142 00:08:03.011 --> 00:08:04.974 And that should allow investors to earn, you know, reasonable, 143 00:08:06.054 --> 00:08:12.978 positive returns on those assets, not spectacularly high in nominal terms, but 144 00:08:12.978 --> 00:08:13.298 you know, 145 00:08:13.298 --> 00:08:18.121 clearly moving back to a more normal level versus that very unnormal. 146 00:08:18.629 --> 00:08:20.890 environment we were in for 10 to 15 years. 147 00:08:21.671 --> 00:08:27.574 And then if you move out into more riskier forms of fixed income, you can get some 148 00:08:27.574 --> 00:08:29.574 yield pickup clearly by taking some credit risk. 149 00:08:29.574 --> 00:08:34.678 I mean, currently, we think the additional compensation for taking credit risk is not 150 00:08:34.678 --> 00:08:36.678 that attractive versus history. 151 00:08:36.800 --> 00:08:43.123 But again, it's really a case that you would expect that yield component to be 152 00:08:43.123 --> 00:08:45.123 the big driver 153 00:08:45.123 --> 00:08:45.625 of returns rather than looking for some major... 154 00:08:46.129 --> 00:08:50.231 kind of compression in yield, which is going to give you a capital uplift over 155 00:08:50.231 --> 00:08:52.231 the longer term. 156 00:08:52.231 --> 00:08:54.231 What about equities? 157 00:08:54.231 --> 00:08:56.815 Equities have had an extraordinary time, referenced, of course, in your answer to 158 00:08:56.815 --> 00:08:58.815 the first question. 159 00:08:58.815 --> 00:09:03.659 And that was to do with US exceptionalism and an annual return of 13% over a long 160 00:09:03.659 --> 00:09:05.659 time period. 161 00:09:05.659 --> 00:09:06.540 But you say revaluation remains a headwind. 162 00:09:06.580 --> 00:09:07.501 Why is it a headwind? 163 00:09:07.861 --> 00:09:10.723 And what do you mean by revaluation in the equity context? 164 00:09:11.403 --> 00:09:14.805 Yes, I mean, I think this is really the flip side or the... 165 00:09:16.502 --> 00:09:23.488 the sort of the payback of after a period of very, very strong returns where 166 00:09:23.488 --> 00:09:25.488 valuations have expanded quite dramatically, I mean, 167 00:09:25.488 --> 00:09:27.051 most notably in the US, but actually, I think at a global level, 168 00:09:27.892 --> 00:09:34.658 there's been a significant positive contribution from valuations increasing 169 00:09:34.658 --> 00:09:36.658 over 170 00:09:36.658 --> 00:09:38.658 recent years. 171 00:09:38.658 --> 00:09:42.325 Our process assumes that there is some mean reversion in valuations over the long 172 00:09:42.325 --> 00:09:42.544 term. 173 00:09:43.305 --> 00:09:48.728 so that we would expect that to be a negative component of returns as we look 174 00:09:48.728 --> 00:09:48.948 ahead. 175 00:09:48.988 --> 00:09:54.451 And clearly, it's hard to predict exactly when that will happen. 176 00:09:54.912 --> 00:09:56.713 But over a 10-year horizon, 177 00:09:57.333 --> 00:10:04.277 we see historically that mean reversion in valuations is a powerful factor and goes a 178 00:10:04.277 --> 00:10:04.758 long 179 00:10:04.758 --> 00:10:06.018 way to explaining the long term. 180 00:10:06.734 --> 00:10:13.618 variation in equity returns and on the measures that we use markets appear to be 181 00:10:13.618 --> 00:10:15.618 expensive relative 182 00:10:15.618 --> 00:10:20.202 to their recent valuation levels and so we are expecting some decline in 183 00:10:20.222 --> 00:10:22.804 valuations again 184 00:10:22.944 --> 00:10:29.588 over the longer term to be to be something which which is a negative factor for for 185 00:10:29.588 --> 00:10:31.588 long-term returns is that going to be 186 00:10:31.588 --> 00:10:36.359 coordinated or will it be geographically specific I mean, there's a fair amount of 187 00:10:36.359 --> 00:10:38.359 geographical variation. 188 00:10:38.359 --> 00:10:43.781 I think on our work, the most expensive markets appear to be the US, which I think 189 00:10:43.781 --> 00:10:45.781 is probably not surprising. 190 00:10:45.781 --> 00:10:46.842 Europe, we also think, looks expensive, 191 00:10:48.262 --> 00:10:54.364 which is maybe slightly counter to some other approaches, which I think focus on 192 00:10:54.364 --> 00:10:56.364 shorter-term valuation measures, 193 00:10:56.364 --> 00:11:00.226 whereas we're trying to look on a longer-term, kind of through-the-cycle 194 00:11:00.226 --> 00:11:02.226 type of valuation approach. 195 00:11:02.226 --> 00:11:05.367 The one place that probably stands out as being a relatively cheap equity market 196 00:11:05.367 --> 00:11:07.367 would be Japan. 197 00:11:07.367 --> 00:11:12.309 So that's one of the markets where we are expecting actually a modest additional 198 00:11:12.309 --> 00:11:14.309 return from a 199 00:11:14.309 --> 00:11:15.350 positive change in valuation over the next 10 years. 200 00:11:16.730 --> 00:11:23.532 And I think the other thing that's quite interesting about Japan, if we're thinking 201 00:11:23.532 --> 00:11:25.532 about returns in unhedged terms, 202 00:11:25.532 --> 00:11:29.734 is that the yen clearly reached extraordinarily cheap levels and has 203 00:11:29.734 --> 00:11:31.734 started to appreciate as well. 204 00:11:31.734 --> 00:11:32.548 If you were to see a world where 205 00:11:33.569 --> 00:11:39.894 Japanese equities continue to perform and the Japanese yen appreciated on a sort of 206 00:11:39.894 --> 00:11:41.894 longer term basis, 207 00:11:41.894 --> 00:11:46.119 the potential for returns from unhedged positions in Japanese equities looks 208 00:11:46.119 --> 00:11:48.119 really quite attractive to us. 209 00:11:48.119 --> 00:11:53.785 Your summary and your, as you call it, call to action for investors sort of plays 210 00:11:53.785 --> 00:11:55.785 into the hands of the question that I just asked you, in fact, 211 00:11:55.785 --> 00:11:56.548 about a geographical diversion. 212 00:11:56.628 --> 00:11:59.150 And you say with low return expectations. 213 00:11:59.390 --> 00:12:05.512 and greater dispersion across regions and asset classes, investors will need to be 214 00:12:05.512 --> 00:12:07.512 more selective. 215 00:12:07.512 --> 00:12:08.973 And this is where you come in, of course, at 91, Daniel. 216 00:12:09.373 --> 00:12:15.094 What is your ideal positioning at the moment and looking forward, and not just 217 00:12:15.094 --> 00:12:17.094 forward in the next few days, weeks, and months, 218 00:12:17.094 --> 00:12:18.375 which we've become used to doing, of course, over the next years? 219 00:12:20.136 --> 00:12:20.836 Yeah, absolutely. 220 00:12:20.836 --> 00:12:26.177 I mean, I guess the headline in terms of the longer-term return outlook is that we 221 00:12:26.257 --> 00:12:28.978 think that a 60-40 equity bond investor, 222 00:12:29.446 --> 00:12:33.268 can expect to make somewhere in the region of four and a half percent per annum. 223 00:12:33.608 --> 00:12:40.511 And I think for most people that would be a disappointing outcome and would not be 224 00:12:40.511 --> 00:12:42.511 what they were hoping for in terms of meeting their longer 225 00:12:42.511 --> 00:12:45.252 term liabilities or their longer term requirements in terms of saving for 226 00:12:45.252 --> 00:12:45.393 retirement. 227 00:12:45.393 --> 00:12:52.175 So we do think that we have to work harder and we have to try and get returns above 228 00:12:52.176 --> 00:12:55.937 and beyond those kind of broad betas that are available in the market. 229 00:12:56.477 --> 00:13:02.811 And so we can hope to to do that through through asset allocation and we can do 230 00:13:02.811 --> 00:13:04.811 that through kind of selecting securities 231 00:13:04.811 --> 00:13:06.352 which will outperform as well and I guess as we sit here 232 00:13:06.392 --> 00:13:12.334 today in our equity positioning we tend to think that the better opportunities are 233 00:13:12.334 --> 00:13:12.474 going to come 234 00:13:12.914 --> 00:13:19.035 outside of the part of the market that's been the big winner over the last 10 to 15 235 00:13:19.035 --> 00:13:21.035 years so I 236 00:13:21.035 --> 00:13:22.496 think people's portfolios are probably overly concentrated today in 237 00:13:22.497 --> 00:13:29.250 the US market and in the largest companies in the US and we think actually that 238 00:13:29.250 --> 00:13:31.250 diversify more internationally, 239 00:13:31.250 --> 00:13:35.494 so into other parts of developed markets and particularly into emerging markets in 240 00:13:35.494 --> 00:13:37.494 the equity portfolio, 241 00:13:37.494 --> 00:13:38.376 can offer a pretty significant return uplift. 242 00:13:38.736 --> 00:13:45.540 And then I think on the fixed income side, I think one big change in the investment 243 00:13:45.540 --> 00:13:47.540 environment, 244 00:13:47.540 --> 00:13:50.403 which seems like it has some chance of being a meaningful kind of longer term 245 00:13:50.403 --> 00:13:50.522 shift, 246 00:13:50.903 --> 00:13:56.086 is that we seem to be moving to a turning point in the US dollar, where, you know, 247 00:13:56.086 --> 00:13:56.106 having been 248 00:13:56.538 --> 00:14:02.941 the world's strongest currency on a sustained basis, it could go into a cycle 249 00:14:02.941 --> 00:14:04.941 of a weaker dollar. 250 00:14:04.941 --> 00:14:08.923 And that has particularly positive implications, I think, for emerging market 251 00:14:08.923 --> 00:14:10.923 fixed income and emerging market currencies. 252 00:14:10.923 --> 00:14:13.545 So again, diversifying your positioning on the fixed income side, 253 00:14:13.725 --> 00:14:18.627 looking at some higher returning opportunities that benefit from a weaker 254 00:14:18.627 --> 00:14:20.627 dollar structurally, 255 00:14:20.627 --> 00:14:22.449 we think those are probably the interesting areas for investors to be 256 00:14:22.449 --> 00:14:22.709 looking at. 257 00:14:22.809 --> 00:14:25.490 Interesting is the correct word, because it's been interesting thus far. 258 00:14:25.990 --> 00:14:30.934 Nearly half the year gone, 2025 is going to be even more interesting, I think, 259 00:14:30.934 --> 00:14:32.934 beyond. 260 00:14:32.934 --> 00:14:32.976 Daniel, thank you very much for your analysis. 261 00:14:33.036 --> 00:14:36.218 Daniel Morgan is multi-asset analyst at 91. 262 00:14:37.259 --> 00:14:44.205 The views and opinions expressed in these podcasts are those of Lindsay Williams and 263 00:14:44.205 --> 00:14:46.205 various contributors and do not reflect the policy, 264 00:14:46.205 --> 00:14:47.948 position or opinion of any other agency, organisation, 265 00:14:48.268 --> 00:14:52.912 employer or company associated with StrictlyBusinessPodcast.com. 266 00:14:53.392 --> 00:15:00.336 assumptions made on the analyses are not reflective of the position of any other 267 00:15:00.336 --> 00:15:02.336 entity other than the speaker or the author. 268 00:15:02.336 --> 00:15:05.797 And since we are critically thinking human beings, these views are always subject to 269 00:15:05.797 --> 00:15:05.917 change, 270 00:15:06.078 --> 00:15:08.658 revision and rethinking at any time. 271 00:15:08.958 --> 00:15:11.359 Please do not hold us to them in perpetuity.