Capital Market Assumptions for 2021 By: Gabriel PotterMBA, AIFA® 2020.12.09

The annual S&P 500 estimates

For the past seven years, we have been posting an annual roundup which looks at the annual advance (or decline) of the US stock market, as measured by the S&P 500, compared to Wall Street analyst estimates from the prior year.  You can look for the next annual roundup for us in January 2021, which follows our established pattern.

This exercise is always fun because we can compare which professional teams were most accurate and who was farthest from the mark.  However, there are a two key disadvantages to this exercise.  The first disadvantage is that we, like most other professionals in our industry, encourage a long-term approach.  The S&P 500 targets for the following year are usually based upon two factors.  First, the four future quarters of earnings (which are reasonably easy to estimate), and second, the best guesses of investor sentiment during the year, which is utterly impossible to estimate.  Earnings can be volatile during a sharp recession, but nothing is as dynamically erratic as the warring impulses of fear and greed inside the minds of market participants.  Real life always intercedes.  Nobody can predict the future, as 2020 has demonstrated over and over again. 

The second disadvantage to this exercise is the fact the S&P 500, while the most popular benchmark for these annual assessments, is only one index.  The S&P 500 represents US large capitalization stocks, but industry professionals use a multitude of various investments to generate optimized and diversified combinations of differing asset types.  Professional investors do not often limit themselves to US large-cap stocks alone.  Instead, most expand their horizons to include smaller US company stock, US bonds, cash, foreign stock, foreign bonds, real estate, and much more. 

Using long term capital market assumptions

While it is fun to compare the annual projections for the S&P 500, it’s not an inherently useful practice for industry professionals who’d like to be able to estimate their financial needs, make reasonable investment allocation decisions, or assess a portfolio’s risk.  There are individual investors who’d like to know if their current asset allocation is projected to generate enough return for their retirement.  There are CFOs who’d like to know if their corporate fixed income holdings are taking on too much risk.  There are actuaries who’d like to know if a company’s pension plan is projected to support their future debt obligations. 

Instead of relying on short term return estimates for a single index, industry professionals use long term capital market assumptions on the risk, return, and intercorrelations between many asset classes.  Many banks, trust companies, governmental institutions, and asset managers create and distribute long term capital market assumption forecasts based on long term secular trends, economic cycle placement, productivity data, earnings forecasts, and so on.  Paradoxically, these long-term estimates are often more robust and less volatile than short term estimates, like the aforementioned 1-year S&P 500 targets.  Over the short term, investor sentiment and unforeseen events are as likely to influence the market’s overall direction as earnings estimates.  In the longer term, overarching forces which determine collective productivity and output is more likely to drive the value of securities as investor sentiment (which waxes and wanes) and ultimately gets washed away in the aggregate. 

Industry professionals most commonly rely on these long-term assumptions two important ways. First, using long term capital market assumptions can help us to make estimates about their combined portfolio’s estimated return.  Second, these assumptions allow managers to create so-called efficient portfolios which, in theory, maximize the return generated by the portfolio given an accepted level of risk.  While portfolio efficiency and asset allocation optimization are fascinating topics, today we are focusing on the return forecasts generated through long term capital market assumptions.

Changes to long term assumptions from 2020 to 2021

Here at Westminster Consulting, we use long term capital market assumptions as the basis for our portfolio return forecasts and asset allocation optimization.  Generally, these long-term assumptions don’t change much year-to-year, and this is by design.  A long-term forecast shouldn’t change much simply in reaction to market action.  In theory, a long-term forecast (if perfect) need hardly change at all.  A short term run up (or run down) in the market prices will have an effect on long term valuations, but when these returns are annualized over a period of many years, the sharp spikes and steep drops tend to average out.  The overarching trends which move the economy – total productivity, total trade, combined employment – should impact the long-term forecasts, and these factors are simply less volatile than the market.

However, when the run-up in the market is truly extraordinary, we do find marked changes in the current market valuations substantially changing the return estimates from year to year.  Here at the tail end of 2020, that’s what we are seeing.  As a specific point of comparison, let’s consider the arithmetic rate of return for the JPMorgan Long Term Capital Market Assumptions of 2021 (published in November 2020) versus their assumptions from one year ago.

JPMorgan - 2020

JPMorgan -2021

Cash

2.0

1.1

US Bonds

3.1

2.2

Foreign Bonds

2.7

2.1

US Large Stocks

6.6

5.1

US Mid Stocks

7.1

5.7

US Small Stocks

8.1

6.3

Foreign Stocks

8.5

7.8

Emerging Markets

11.2

9.2

US REITs

7.1

7.6

Hedge Funds

4.8

3.5

Commodities

3.7

3.5


 

The results are pretty clear.  Across the board, the expectations for returns have materially diminished. There have been two great shifts which account for the change in valuations.  First, the overall economy has meaningfully slowed across the world a result of the COVID19 pandemic.  Second, despite the material slowdown, some equity markets – the US growth indices are particular – have enjoyed an astounding price recovery and, despite the slowdown, they are hitting successive all-time highs.  This disconnect between modest economic growth trends and skyrocketing valuation is making Wall Street analysts rethink the value proposition of different asset classes compared to where we were a year ago.

Comparing to other results

JPMorgan’s long-term capital market assumptions are reasonably comprehensive, but are they an outlier?  There are many publicly available capital market assumption tables, but they do come out at different times of the year.  The timing of these reports will influence their results since the year has been very volatile.  In other words, an analyst team making long term capital market assumptions in April will have a very different value assessment because key equity markets have advanced 50% in those past seven months.  Furthermore, some teams generate results on different time-horizons, which also influences the result; where possible, the following capital market assumptions are based on 10-year forecasts, using arithmetic returns.

With these caveats noted, here is how the JPMorgan results compare to other capital market assumptions from competing firms.

 

JPMorgan

Northern Trust

Invesco

Vanguard

Blackrock

UBS

SEI

Morgan Stanley

Average

Cash

1.1

0.1

0.4

1.0

-

0.2

0.6

1.1

0.6

US Bonds

2.2

2.3

1.5

1.2

0.8

0.3

2.1

1.5

1.5

Foreign Bonds

2.1

1.6

1.9

1.0

0.4

-0.1

-

2.1

1.3

US Large Caps

5.1

4.7

7.0

4.7

5.0

4.9

7.4

5.0

5.5

US Mid Caps

5.7

-

6.6

-

-

-

-

5.1

5.8

US Small Caps

6.3

-

10.3

5.0

5.6

-

9.9

7.2

7.4

Foreign Stocks

7.8

4.8

8.3

8.4

7.0

6.8

8.9

6.9

7.4

Emerging Market

9.2

5.4

11.2

-

6.4

11.8

13.0

7.7

9.2

US REITs

7.6

6.3

11.1

4.4

6.1

4.8

6.1

7.5

6.7

Hedge Funds

3.5

2.6

7.0

-

5.1

3.7

-

4.4

4.4

Commodities

3.5

-

5.9

-

-

-

-

1.4

3.6

Published

Nov-20

Aug-20

Nov-20

Nov-20

Sep-20

Jun-20

Jun-20

Apr-20

Our data suggests that JPMorgan’s results are not an outlier.  Their current long-term assumptions are typically within one percentage point of the peer group average.  Moreover, our research suggests other capital market assumptions from competing firms have similarly been revised downward for 2021; this effect is more pronounced for the recent capital market assumption tables which came out after much of the 2020 recovery had occurred.

What does this mean for you?

In practical terms for today’s investors, here is the important idea we’d like to leave you with:  we have seen extraordinary returns over the past few years, but no recovery speedier than the summer and fall of 2020.  Professional market analysts generally believe medium term market returns are going to be lower.  More specifically, we have seen the future return forecasts for US equities lowered as a result of the large advances we have experienced thus far in 2020. 

The long-term capital market assumptions are just that – assumptions.  These represent some of the educated guesses of smart and dedicated professionals, but they are still only guesses.  Nobody knows what the future will bring, but its worth being prepared for the possibility of a lower-return environment and considering how that will affect your financial plans as corporation, governmental institution, and an individual investor.

Sources:

  1. https://am.jpmorgan.com/us/en/asset-management/institutional/insights/portfolio-insights/ltcma/
  2. https://www.capitalmarketassumptions.com/
  3. https://www.invesco.com/emea/en/invesco-insights/insights/2021-Long-Term-Capital-Market-Assumptions.html
  4. https://advisors.vanguard.com/insights/article/marketperspectivesnovember2020
  5. https://www.blackrock.com/institutions/en-us/insights/charts/capital-market-assumptions
  6. https://www.ubs.com/global/en/asset-management/insights/capital-market-assumptions/looking-ahead.html
  7. https://graystone.morganstanley.com/graystone-consulting-farmington-hills-mi/documents/field/g/gr/graystone-consulting--farmington-hills--mi/Annual%20Update%20of%20our%20Capital%20Market%20Return%20Forecasts.pdf

 

DISCLOSURES & DISCLAIMERS:

The information contained herein has been obtained from sources that we believe to be reliable, but its accuracy and completeness are not guaranteed.  Westminster Consulting, LLC reserves the right at any time and without notice to change, amend, or cease publishing the information.  It has been prepared solely for informative purposes.  It is made available on an "as is" basis.  Westminster Consulting, LLC does not make any warranty or representation regarding the information.  Without prior written permission from Westminster Consulting, LLC, it may not be reproduced, in whole or in part, in any form. The information in this document is confidential and proprietary to Westminster Consulting, LLC including its business units and may be legally privileged. Any unauthorized review, printing, copying, use or distribution of this document by anyone else is prohibited and may be a criminal offense. Indices mentioned are unmanaged and cannot be invested into directly.  Past Performance does not guarantee future results.

 

 

 

 

Gabriel Potter

Gabriel is a Senior Investment Research Associate at Westminster Consulting, where he is responsible for designing strategic asset allocations and conducts proprietary market research.

An avid writer, Gabriel manages the firm’s blog and has been published in the Journal of Compensation and Benefits,...

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