Each year, BNY Mellon Investment Management develops capital return assumptions for more than 50 asset classes around the world. Our assumptions form the basis of our long-term point of view, serving as a 10-year forecast of how we believe each asset class will perform. We then combine those assumptions with our analysis of current market conditions, as well as our forward-looking views on the economy, corporate earnings and interest rates, to determine our 12- to-18 month outlook. This process helps to inform the investment and planning advice we provide to our clients.

This year, our capital market return assumptions point to lower returns relative to more recent historical results, particularly for equities. However, we also anticipate lower volatility across asset classes compared to our expectations in 2016. In light of these changes, we feel that it may be an opportune time to conduct reviews with our clients to ensure that they are still on track to meet their goals.

How We Develop Our Assumptions

Our capital market assumptions are created by a team of 30 BNY Mellon investment professionals, including investment strategists, portfolio managers, research specialists and economists. This team uses a range of qualitative and quantitative metrics to evaluate various asset classes, such as the expected growth of earnings-per-share, interest rate forecasts, and comparisons between average price-to-earnings ratios and their forecasts.

We're confident in our assumptions —back testing has shown that they have a strong correlation to the future 10-year annualized returns for U.S. equity markets outside of isolated, extreme market conditions. (See Exhibit 1.)

Exhibit 1. Our Return Assumptions vs. Actual Returns

Four Key Considerations for 2017

When developing the capital market assumptions for 2017, our team began with consensus data and general expectations about market performance and augmented it with in-depth research on the trends that are affecting global markets. In doing so, the team identified four key considerations that affected their conclusions.

Elevated Uncertainty

It's no secret that 2017 has been a politically volatile year. The uncertainty surrounding U.S. tax policy and concerns around “de-globalization" (i.e., restrictions on the movement of capital, such as tariffs, or restrictions on the movement of people, such as stricter immigration laws and enforcement) have the potential to disrupt existing market trends.

An Aging Population

Around the world we're seeing the impact that an aging population can have on a country's economy. As the population ages, a country's economic growth is dampened by declining productivity. This can be seen in the correlation between a country's median age and government bond yields — when the median age rises, interest rates tend to fall. The median age of a U.S. citizen in 2017 is roughly 38 years old and is expected to continue to rise in the coming years.

Gradual Interest Rate Rise

That said, interest rates really don't have much further to fall at the moment. Despite recent increases, interest rates are still near historic lows due to stimulative monetary policy that has been in effect since the recession in 2008. We think interest rates will begin to creep up slightly over the next five to six years, both in the U.S. and in the developed world, though the demographic headwinds mentioned earlier should keep them below historical averages.

Inflation Expectations

Similarly, those demographic headwinds should keep the annualized 10-year inflation rate in the U.S. below the consensus estimate of 2.2% — we feel it will be closer to the Federal Reserve's target of 2%. Outside of the U.S., we expect inflation to be even lower — just 1.5%.

A Good Opportunity to Review Long-Term Plans

On average, we believe that U.S. equities will return 6.3% over the next 10-year period. This incorporates reductions in expected returns of about 1% for large cap, mid cap, small cap and international equities from our 2016 estimates.

Exhibit 2. Expected Change in Returns by Asset Class

Some investors, particularly those who rely on their investments for income, could discover that these new return expectations predict a shortfall between their portfolio returns and their rate of spending. One option would be to reweight the portfolio in pursuit of higher returns — which would also mean taking on more risk. Another option would be to look closely at current assets, expenses and liabilities to see how much is really needed to maintain his or her current standard of living in a potential lower-return environment.

Whatever the appropriate course of action may be, we are working to devise clear, logical next steps that reflect our clients' intentions and address their needs, while remaining realistic about what it will take to meet their goals and objectives in a prudent manner.

Our wealth managers are partnering with clients to help them understand how these reductions might affect their plans and ensure that they stay focused on the bigger picture — their long-term goals. While this evaluation includes an analysis of current asset allocation, projected expenses and cash flow, it also relies heavily on personal, one-to-one conversations about long-term needs and objectives. By understanding what it is our clients want to accomplish with their wealth, we're able to better determine the impact that the potential reduction in long-term returns will have on them, and whether any adjustments need to be made to ensure they remain on track to meet their goals.

Stay Focused on the Future

At BNY Mellon Wealth Management, we help our clients develop plans that are tailored to their needs, aimed at their goals and mindful of their tolerance for risk. Our capital market assumptions are just one of the factors we use to determine our strategic asset allocations and play a role in helping us determine the best long-term plan. By taking an informed and educated look into the future, we hope to avoid overreactions to short-term volatility and the vagaries of current events. As always, the surest path to success is to have a solid, long-term plan and to stick to it.

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