You're listening to Strictly Business Podcast with Lindsay Williams.
I received a piece of work entitled Capital Markets Assumptions, A New
Investment Reality Takes Shape.
It came from the desk of Daniel Morgan, multi-asset analyst at 91.
And Daniel collated data up to the 31st of March of 2025.
The piece was published on May the 6th, 2025, and immediately alarm bells started
ringing.
in my mind, because in the piece,
Daniel assessed the long-term expected returns across global asset classes.
And the latest edition of CMA, based on data, as I said, at the end of March,
showed a modest uplift in expected returns across both equities and fixed income.
But it didn't take into account, of course, tariffs, which means, in a sense,
it was out of date the moment it hit people's desks.
Let's sort of qualify that now.
Daniel is with me.
Daniel, tricky times to write reports.
Well, I mean, I think the nice thing about the work that we do that leads into these
capital market assumptions is that
it actually gives us that chance to sort of take a step back from some of the
excitement and the noise that we sort of see day to day
and think about the long term outlook for financial markets.
So we're trying to think about returns on a 10 year horizon.
And clearly one one very important factor there is.
valuation is the price you pay when you get into the market so the volatility that
we've seen uh clearly has an impact i mean actually as
we sit here today in sort of mid-may we kind of struck this work based on market
levels at the end
of march 31st of march okay free free the latest round of tariff excitement and
actually
we've sort of had a big round trip so so in terms of where we are today we're sort
of back to roughly the levels we were at on the
31st of march where this this work is dated.
Now, things will change again, but, you know, as we sit here today, I think we're
sort of actually in the same spot as we were at the end of March.
So you could have gone away when you first collated all this data and wrote this
report, gone away for six weeks with no cell phone, come back today,
and absolutely nothing has changed.
Well, obviously, that's a little bit of an exaggeration, but I get your point.
You made a case study, and you say, rethinking US exceptionalism and European
renaissance.
During that period, US exceptionalism was being doubted, very much so.
but European Renaissance was very much a theme.
Is it going back to the other extreme now?
In other words, as I said, Mr.
Trump suddenly having this resurgence of confidence.
Yeah, I mean, I think when we sort of thought about the subject of
US exceptionalism that's clearly been at the front of everyone's minds,
we sort of tried to take a step back and put sort of things in a historical
perspective.
I think that's kind of one of the things that we can do through this work is take
that sort of...
longer view, be more data-driven, more analytical in that sense.
And I guess we kind of looked at the 10-year period up to the end of 2024 as
being kind of the high
point of US exceptionalism, I guess.
And that term probably means different things to different people.
But one of the ways that it was most clearly expressed in markets was this
incredible outperformance of US equities over that decade.
So I think for the 10 year period to the end of 2024.
US equities returned 13% per annum, which was basically double the return of the
next best region.
So Europe and Japan returned around 6.5% in dollars.
And it was about three times the return of the UK and emerging markets over that time
horizon.
Really, really dramatic outperformance.
And I guess the question then is where we go from here.
So yes, that's clearly the next part to think about.
So read US exceptionalism and read equity outperformance.
And that has been challenged, of course, and it was challenged quite spectacularly,
but very, very briefly as well.
And I think with the performance on May the 12th, I think it was,
the markets clawed back everything and in fact rose above the Liberation Day
sell-off or the days
after the Liberation Day speech, that famous or infamous one.
You say that the dynamics may be changing in Europe and it could be nearing a...
turning point?
Is it because of the demise of US exceptionalism, albeit brief, or is there
other factors to play here?
I mean, I think related to the broader global environment, global changes,
but I think the positive case for Europe actually depends more on domestic factors
than on,
you know, sort of negatives elsewhere, I think.
And I mean, again, sort of taking the the longer outside view of this.
Europe has been through...
a sort of prolonged period of kind of stagnation at least in terms of uh
corporate profits and corporate revenue so you know it
basically took until this year for uh the dividends paid by european companies to
um sort of move above the peak that they hit prior to the gfc so you know, what is
that now, 17 years ago,
a 17-year period of no growth essentially in the level of income paid out by
European corporates.
And so that's kind of a pretty spectacular outcome historically.
And it seems that the reasons for that were, you know, dealing with the legacies
of the GFC.
And if we think that actually most of those issues in terms of the debt
overhang, for example, are sort of working their way out of the system.
And we look to a world where
European governments have decided to sort of break with austerity and the sort of
fiscal
rules that they'd imposed on themselves and invest more for the future,
which is probably one of the sort of the key imbalances or weaknesses in the
European economic setup in recent
years.
I think it seems reasonable as a sort of starting point to think that actually, you
know, after a period of stagnation,
we can return to levels of growth that we saw.
more similar to the levels of growth we saw historically in the decades leading up
to the GFC.
So there were some unsustainable aspects to that in the boom years.
But on a longer term view, steady growth in corporate profitability in Europe was a
factor for many decades.
And I think there's a reasonable case to be made that we're going back to that kind
of world after a very difficult period.
Yes, and is this a pan-European movement or is it in spots?
In other words, is Spain doing something correct and Germany not?
I mean, I think certainly when we're trying to take a longer sort of forecast
horizon here,
we have to try and think more in terms of broader markets and broader sort of
regional
views.
It's just the more, the narrower you get, the more sort of you're exposed to just,
you know,
individual things happening that you didn't expect in individual markets.
So at least at the level of kind of the capital market assumptions work,
we're taking kind of an overall view on the European economy, I guess,
rather than on the specifics in any individual country or sector.
Okay, let's have a look at some asset classes now and start with fixed income.
Income continuing to drive the bulk of return potential, you say.
Could you expand upon that, please?
Yes, so I mean, I think if we think about sort of government bonds in developed
markets as a starting point,
we have seen a big reset in yields in recent years.
So we're now, we have a global interest rate structure, which looks more like the
kind of the prevailing environment in the
2000s. So having come out of this world of zero and even negative policy rates and
interest rates
in quite a lot of developed markets.
We've now shifted into a place where it seems like sort of through the cycle
interest rates,
neutral interest rates in developed markets are resetting at a more positive
level.
And that should allow investors to earn, you know, reasonable,
positive returns on those assets, not spectacularly high in nominal terms, but
you know,
clearly moving back to a more normal level versus that very unnormal.
environment we were in for 10 to 15 years.
And then if you move out into more riskier forms of fixed income, you can get some
yield pickup clearly by taking some credit risk.
I mean, currently, we think the additional compensation for taking credit risk is not
that attractive versus history.
But again, it's really a case that you would expect that yield component to be
the big driver
of returns rather than looking for some major...
kind of compression in yield, which is going to give you a capital uplift over
the longer term.
What about equities?
Equities have had an extraordinary time, referenced, of course, in your answer to
the first question.
And that was to do with US exceptionalism and an annual return of 13% over a long
time period.
But you say revaluation remains a headwind.
Why is it a headwind?
And what do you mean by revaluation in the equity context?
Yes, I mean, I think this is really the flip side or the...
the sort of the payback of after a period of very, very strong returns where
valuations have expanded quite dramatically, I mean,
most notably in the US, but actually, I think at a global level,
there's been a significant positive contribution from valuations increasing
over
recent years.
Our process assumes that there is some mean reversion in valuations over the long
term.
so that we would expect that to be a negative component of returns as we look
ahead.
And clearly, it's hard to predict exactly when that will happen.
But over a 10-year horizon,
we see historically that mean reversion in valuations is a powerful factor and goes a
long
way to explaining the long term.
variation in equity returns and on the measures that we use markets appear to be
expensive relative
to their recent valuation levels and so we are expecting some decline in
valuations again
over the longer term to be to be something which which is a negative factor for for
long-term returns is that going to be
coordinated or will it be geographically specific I mean, there's a fair amount of
geographical variation.
I think on our work, the most expensive markets appear to be the US, which I think
is probably not surprising.
Europe, we also think, looks expensive,
which is maybe slightly counter to some other approaches, which I think focus on
shorter-term valuation measures,
whereas we're trying to look on a longer-term, kind of through-the-cycle
type of valuation approach.
The one place that probably stands out as being a relatively cheap equity market
would be Japan.
So that's one of the markets where we are expecting actually a modest additional
return from a
positive change in valuation over the next 10 years.
And I think the other thing that's quite interesting about Japan, if we're thinking
about returns in unhedged terms,
is that the yen clearly reached extraordinarily cheap levels and has
started to appreciate as well.
If you were to see a world where
Japanese equities continue to perform and the Japanese yen appreciated on a sort of
longer term basis,
the potential for returns from unhedged positions in Japanese equities looks
really quite attractive to us.
Your summary and your, as you call it, call to action for investors sort of plays
into the hands of the question that I just asked you, in fact,
about a geographical diversion.
And you say with low return expectations.
and greater dispersion across regions and asset classes, investors will need to be
more selective.
And this is where you come in, of course, at 91, Daniel.
What is your ideal positioning at the moment and looking forward, and not just
forward in the next few days, weeks, and months,
which we've become used to doing, of course, over the next years?
Yeah, absolutely.
I mean, I guess the headline in terms of the longer-term return outlook is that we
think that a 60-40 equity bond investor,
can expect to make somewhere in the region of four and a half percent per annum.
And I think for most people that would be a disappointing outcome and would not be
what they were hoping for in terms of meeting their longer
term liabilities or their longer term requirements in terms of saving for
retirement.
So we do think that we have to work harder and we have to try and get returns above
and beyond those kind of broad betas that are available in the market.
And so we can hope to to do that through through asset allocation and we can do
that through kind of selecting securities
which will outperform as well and I guess as we sit here
today in our equity positioning we tend to think that the better opportunities are
going to come
outside of the part of the market that's been the big winner over the last 10 to 15
years so I
think people's portfolios are probably overly concentrated today in
the US market and in the largest companies in the US and we think actually that
diversify more internationally,
so into other parts of developed markets and particularly into emerging markets in
the equity portfolio,
can offer a pretty significant return uplift.
And then I think on the fixed income side, I think one big change in the investment
environment,
which seems like it has some chance of being a meaningful kind of longer term
shift,
is that we seem to be moving to a turning point in the US dollar, where, you know,
having been
the world's strongest currency on a sustained basis, it could go into a cycle
of a weaker dollar.
And that has particularly positive implications, I think, for emerging market
fixed income and emerging market currencies.
So again, diversifying your positioning on the fixed income side,
looking at some higher returning opportunities that benefit from a weaker
dollar structurally,
we think those are probably the interesting areas for investors to be
looking at.
Interesting is the correct word, because it's been interesting thus far.
Nearly half the year gone, 2025 is going to be even more interesting, I think,
beyond.
Daniel, thank you very much for your analysis.
Daniel Morgan is multi-asset analyst at 91.
The views and opinions expressed in these podcasts are those of Lindsay Williams and
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assumptions made on the analyses are not reflective of the position of any other
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And since we are critically thinking human beings, these views are always subject to
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revision and rethinking at any time.
Please do not hold us to them in perpetuity.