Continued support for asset returns

Our capital market expectations (CME) are designed to provide annualized return expectation over a longer-term horizon, typically viewed as being five to 10 years.

Franklin Templeton Multi-Asset Solutions

Every year we review the data that drive capital markets—current valuation measures, historical risk premia, economic growth and inflation prospects—to provide the foundation for our forecasts. We update the models that we use and review their continued appropriateness. Where necessary, we phase in required changes. Crucially, our models are based on first-principle economic relationships and reflect seasoned practitioner judgment.

We continue to include as part of every capital market forecast a measure of the expected volatility of that asset class, informed by long-term observed standard deviation of returns. Given that global central banks’ quantitative easing policies may have repressed both equity and bond market volatility over recent years, our approach to modeling volatility avoids the recency bias of some alternative approaches and is particularly appropriate at a time when leading central banks are approaching the limits of conventional interest rate policy and some advocate greater use of fiscal measures.

Our capital market expectations (CME) are designed to provide annualized return expectations over a longer-term horizon, typically viewed as being five to 10 years. Specifically, we calculate geometric mean return expectations over a seven-year period, which approximates the average length of a US business cycle.1 This length of horizon is especially relevant as we proceed towards the latter part of an unusually long economic expansion in the United States.

Our modeling approach is based on a blend of objective inputs, quantitative analysis, and fundamental research. We call it “quantamental.” Underpinning these inputs are assumptions on the sustained growth rates that developed and emerging economies can expect to achieve and the level of price inflation they will likely experience. This approach is forward-looking, rather than being based on historical average returns. This is especially important in an evolving macroeconomic environment.

Contributors

  • Head of Quantitative Strategies, Franklin Templeton Multi-Asset Solutions
  • Head of Multi-Asset Research Strategies, Franklin Templeton Multi-Asset Solutions

Summary

We believe global stocks have greater performance potential than global bonds, supported by continued global growth. Within both bonds and equities, we continue to forecast stronger return potential for emerging markets, over a seven-year investment horizon. With short-term interest rates and government bond term-premia remaining below historical averages, we see a lower performance potential from government bonds.

Our strongest convictions:

  • Moderate inflation and fiscal stimulus help sustain global growth
  • Global equities outperform global bonds
  • Emerging markets outperform developed markets

ENDNOTES

  1. Since 1945, the National Bureau of Economic Research has defined 11 US business cycles, with an average duration of 69.5 months.

What Are the Risks?

Stock prices fluctuate, sometimes rapidly and dramatically, due to factors affecting individual companies, particular industries or sectors, or general market conditions. Bond prices generally move in the opposite direction of interest rates. Thus, as the prices of bonds in an investment portfolio adjust to a rise in interest rates, the value of the portfolio may decline. Special risks are associated with foreign investing, including currency fluctuations, economic instability and political developments. Investments in developing markets involve heightened risks related to the same factors, in addition to those associated with their relatively small size, lesser liquidity and lack of established legal, political, business, and social frameworks to support securities markets. Such investments could experience significant price volatility in any given year. Derivatives, including currency management strategies, involve costs and can create economic leverage in a portfolio, which may result in significant volatility and cause the portfolio to participate in losses (as well as enable gains) on an amount that exceeds the portfolio’s initial investment. Investing in the natural resources sector involves special risks, including increased susceptibility to adverse economic and regulatory developments affecting the sector—prices of such securities can be volatile, particularly over the short term. Some strategies, such as hedge fund and private equity strategies, are available only to pre-qualified investors, may be speculative and involve a high degree of risk. An investor could lose all or a substantial amount of his or her investment in such strategies. Real estate securities involve special risks, such as declines in the value of real estate and increased susceptibility to adverse economic or regulatory developments affecting the sector.