Executive Summary: 2021 10-Year Capital Market Assumptions

This year’s forecasts for asset class returns, volatilities and correlations over the next decade take on even greater significance given the unprecedented prevailing economic and capital market circumstances.

The annual publication of our 10-Year Capital Market Assumptions (CMAs) affords the opportunity to share our projections for asset class returns, volatilities and correlations over the next decade. We consider this yearly exercise to be of importance given the role played by the CMAs in shaping the design of our investors’ long-term policy portfolios. However, we believe this year’s forecasts take on even greater significance given the unprecedented prevailing economic and capital market circumstances that heavily influenced our analysis and ultimately our 2021 10-year projections. 

Impact of the Global Pandemic

While the tragic effects of the pandemic continue to be felt globally, the development of effective vaccines thanks to the remarkable efforts of the science community has paved the way for the global economy to gradually emerge from its self-imposed lockdown. We hold the view that global economic activity will return to its pre-pandemic levels by the end of 2021. However, in many other respects we do not expect a return to pre-crisis economic and capital market norms. 

Reaction to the Global Pandemic

Methodology: Planning for Uncertainty

There is a high degree of uncertainty regarding the likely path of three key inputs into our return forecasts: short-term interest rates, inflation and GDP growth. For the first time this year, in partnership with BNY Mellon’s Chief Economist Shamik Dhar, we have incorporated a scenario-based approach to estimating these inputs where we have assigned probability weights to plausible three-year recovery and recessionary scenarios for the post-pandemic global economy. 

Summary of Macroeconomic Scenarios

The probability weighted average estimate for each input is then incorporated into our CMAs. At the margin, this approach has resulted in only modest year-over-year adjustments to our forecasts. We have increased our inflation assumption by 0.3% from 2.1% to 2.4% and, on average, our equity market return forecasts have increased by 0.5% due to a small increase in our GDP growth assumptions.

Asset Class Assumptions

Key Portfolio Implications

The most important conclusions we draw from the 2021 CMAs relate to their profound investment implications, which are best framed through the lens of a traditional balanced 60%/40% portfolio.  For much of the last 30 years, U.S. investors seeking to generate stable capital growth have been well served by holding a portfolio comprising an approximate equal mix of U.S. Equities (60%) and U.S. Investment-Grade Bonds (40%). This portfolio has over delivered on its joint “promise” to grow real wealth (after inflation), provide a reliable source of income and diversify equity risk. Without a doubt, the “hero” of this story has been the fixed income component. To a fault, it has delivered on all three of its roles:

  1. It has contributed more than its fair share to the total return of the portfolio thanks to the 30-plus-year decline in nominal interest rates
  2. It produced a stable income stream thanks to the (mostly) healthy macroeconomic environment that has helped sustain a low investment-grade default environment
  3. The equity bond correlation has remained very low throughout this time period, ensuring that the aggregate portfolio enjoyed the full benefits of diversification

Assuming the motive for holding a balanced portfolio is unchanged, our CMAs suggest that this simple but very effective portfolio will struggle to meet these same objectives in the next decade. However, in the same way that our 2021 CMAs help frame the challenge faced by a traditional balanced portfolio, they also serve as a guide for how investors may overcome this challenge. In this regard, we emphasize four actions a balanced investor should consider.

Actions to Consider

Conclusion

CMAs are utilized across a range of investment and planning activities. These assumptions influence our strategic asset allocation models, which are tailored to our clients’ objectives and risk tolerance as well as tax sensitivity. From this starting point, we recommend tactical asset allocation shifts based on shorter-term market dislocations as well as tax sensitivity, where applicable.

We welcome you to review our 2021 Capital Market Assumptions. As you navigate the next decade, we at BNY Mellon Wealth Management are available to help you review these assumptions as they relate to your investment plan.

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