2018 will be a “coming of age” for financial markets around the world as central banks wind down QE and economic growth gains traction, that’s the main takeaway from Robeco’s latest Expected Returns 2018-2022 report.
Robecco’s report, which is published every year and gives a five-year expected returns forecast for the period ahead, has been named as the best asset allocation paper of 2017 by Savvy Investor, the world’s leading research network for institutional investors.
Robecco’s forecasts are slightly more optimistic than those of other Wall Street analysts. While the outlet does expect there to be more volatility as central banks wind down their balance sheets, going forward positive returns from all assets apart from government bonds are expected.
S&P 500 projected return: Bull case
Global developed market equities are expected to return 5% per annum through 2022 and emerging market equities 6.25%. Government bonds are on track to lose 2.5% per annum according to Robecco, and high yield will earn 0.25%. Commodities, real estate, and cash are set to return 2.75%, 4.25%, and 0.50%.
The calculation for equity returns is based on the comprehensive dataset compiled by Dimson, Marsh, and Staunton. These researchers gathered the returns for three key assets, equities, bonds, and bills, for 21 major countries between 1900 and 2016. The data shows that over the 116 years studied, average and the median valuation adjusted excess returns of equities over cash were 4.6% respectively, while over bonds they were 3.2% and 3.0%. In 2013, the trio added to their findings by establishing a global risk premium of equities over cash using their broad data set. The figures gave an excess return of their global equity index over cash and bonds of 4.1% and 3.2% respectively.
Robecco's analysts go on to derive the real global equity return from a theoretical point, which they place at 4%. Adding in 3% inflation gives an estimate for the nominal total return of around 7%. This implies a risk premium of 3.5% versus cash.
Robecco's forecast appears relatively upbeat compared to the latest research paper from GMO’s James Montier and co-author Matt Kadnar.
Montier also uses historical returns to come up with a forecast for future equity performance, but his figures show a different picture.
S&P 500 projected return: Bear case
Specifically, Montier’s paper considers the key historical drivers of equity returns since 1970. During this 30 year period, an investment in the S&P 500 has produced a real total annual return of 6.3%, of which 3.4% has come from dividends while 2.3% has come from growth. Margin expansion has accounted for 0.5% of returns, and multiple expansion has accounted for 0.1%.
However, between 2015 and June 30, the S&P 500 has produced a total real return of 13.6% per annum, with multiple expansion, accounting for 3.8% of the growth. Margin growth is the second-largest contributor, accounting for 3.2% of the S&P 500's total return. Returns from dividends only accounted for 2.8% of the S&P 500's total return. What this means is that, according to Montier, it's only a matter of time before stocks start to fall. Profit margins and earnings multiples cannot go up forever.
Montier and Kadnar estimate that assuming the markets price-earnings multiple returns to its equilibrium of 16, down from the current 24.4, and profit margins revert to the equilibrium of 5.7%, compared to 6.9% investors should expect an annualized return of -3.9% for the next seven years. The dividend component will remain the same.