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Long-Term Capital Market Assumptions FOR INSTITUTIONAL/WHOLESALE/PROFESSIONAL CLIENTS AND QUALIFIED INVESTORS ONLY – NOT FOR RETAIL USE OR DISTRIBUTION PORTFOLIO INSIGHTS 2021 | 25TH ANNUAL EDITION Long-Term Capital Market Assumptions Time-tested projections to build stronger portfolios TABLE OF CONTENTS 4 FOREWORD 5 EXECUTIVE SUMMARY A new portfolio for a new decade 16 MACROECONOMIC ASSUMPTIONS A new business cycle begins: Growth prospects unshaken; range of possible long-run inflation outcomes widens I. THEMATIC ARTICLES 24 CLIMATE POLICY CHOICES AND THE ECONOMY Weighing the investment implications of climate change policy 33 NEW CYCLE, NEW POLICY The fiscal decade: The promises, problems and potential of fiscal stimulus 44 HOW INDEBTEDNESS IMPACTS RETURNS Debt, debt everywhere: The implications of a high debt world 53 IN PURSUIT OF ALPHA, INCOME AND DIVERSIFICATION Alternatives: From optional to essential II. ASSUMPTIONS 64 CURRENCY EXCHANGE RATE ASSUMPTIONS U.S. dollar downtrend may be finally underway 69 FIXED INCOME ASSUMPTIONS A long road back to normal 76 EQUITY ASSUMPTIONS Tougher starting point, lower returns 84 ALTERNATIVE ASSETS ASSUMPTIONS A welcome source of alpha, income and diversification 102 VOLATILITY AND CORRELATION ASSUMPTIONS After near-term choppiness, long-run forecast remains stable 109 PORTFOLIO IMPLICATIONS Actionable insights for diversifying portfolios amid extended valuations III. ASSUMPTIONS MATRICES 118 U.S. DOLLAR 120 EURO 122 STERLING IV. APPENDIX 126 GLOSSARY 127 ACKNOWLEDGMENTS J.P. MORGAN ASSET MANAGEMENT 3 FOREWORD A global pandemic can shift our perspective, making it more difficult to focus on the future. But, of course, this is the essential task of any long-term investor, regardless of the stresses and challenges in the moment. After all, the comment widely attributed to Britain’s wartime prime minister Winston Churchill sums it up well: “If you are going GEORGE GATCH through hell, keep going.” Amid today’s demanding investing environment, we present the 2021 edition of J.P. Morgan Asset Management’s Long-Term Capital Market Assumptions (LTCMAs). In our 25th year of producing capital market estimates, we incorporate more than 200 asset and strategy classes;1 our return assumptions are available in 16 base currencies. Over the years, many investors and advisors have come to depend on our assumptions to inform their strategic asset allocation, build stronger portfolios and establish reasonable expectations for risks and returns over a 10- to 15-year time frame. Moreover, we seek each year to recalibrate our long-run approximations as we incorporate the new information presented by markets, policymakers and economic data alike. We formulate our LTCMAs as part of a deeply researched proprietary process that draws on quantitative and qualitative inputs as well as insights from experts across J.P. Morgan Asset Management. Our own multi-asset investment approach relies heavily on our LTCMAs: The assumptions form a critical foundation of our framework for designing, building and analyzing solutions aligned with our clients’ specific investment needs. This edition of our assumptions explores how the policies adopted to tackle the COVID-19 crisis will affect the next cycle. The alignment of monetary and fiscal policy in the same supportive direction is perhaps the biggest single difference in the fabric of the economy between this new cycle and the last one. Over our investment horizon, we see modest global growth and somewhat constrained returns in many asset markets. And yet we are optimistic that with flexibility in portfolio strategy and precision in its execution, investors can harvest an acceptable return without an unacceptable increase in portfolio risk. Whatever approach investors take, a considered, long-term strategic perspective is essential. So too is careful manager selection and attentiveness to the power of active asset allocation. We look forward to working with you to make the best use of our assumptions in setting your own strategic perspective and pursuing your investment goals. On behalf of J.P. Morgan Asset Management, thank you for your continued trust and confidence. As always, we welcome your feedback. George Gatch Chief Executive Officer, Asset Management 1 Key asset classes in USD, GBP and EUR presented at the back of this book; all others available via our website or from your J.P. Morgan representative. 4 LONG-TERM CAPITAL MARKET ASSUMPTIONS EXECUTIVE SUMMARY A new portfolio for a new decade John Bilton, CFA, Head of Global Multi-Asset Strategy, Multi-Asset Solutions Karen Ward, Chief EMEA Strategist, Global Market Insights Strategy Tim Lintern, CFA, Global Strategist, Multi-Asset Solutions Michael Akinyele, Global Strategist, Multi-Asset Solutions IN BRIEF • The global pandemic of 2020 precipitated the sharpest recession on record and also the fastest-ever rebound. As the economy begins to move toward a new business cycle, we expect the extensive deployment of monetary and fiscal stimulus to leave a lasting imprint. • While the closer alignment of monetary and fiscal support will distinguish the next cycle from the last, many important issues transcend business cycles. Issues such as climate change, aging populations and technology adoption continue to affect economies and asset markets, and in some cases may have been made even more acute by the upheaval of the pandemic. • Despite the abruptness with which the last cycle ended and the depth of the economic shock, our long-term growth and inflation projections are little changed. However, around our point estimates we believe there is a fatter and flatter distribution of tail risks. • Forecasts for public asset market returns, meanwhile, fall sharply: The low starting point for yields translates to a bleak outlook for government bonds, and elevated valuations for equity present a headwind for stocks. Credit and emerging market debt remain brighter spots, but increasingly it is to alternative assets that investors must turn to find higher returns. • As we move further into the 2020s, we will need to adopt a new portfolio for the new decade. With expanded opportunity sets and acceptance that truly safe assets no longer offer income, investors can more fully exploit the specific trade-offs that a portfolio can tolerate in order to harvest returns. J.P. MORGAN ASSET MANAGEMENT 5 EXECUTIVE SUMMARY A NEW PORTFOLIO FOR A NEW DECADE In the immediate aftermath of an acute crisis, it can be difficult to We believe that the imprint of their policy actions will linger well look beyond the current news flow and think about the long term. into the coming decade. Already, central banks such as the Federal But with the global pandemic still dominating the headlines, Reserve (Fed) are adopting new frameworks1 to manage the that task is even more challenging – and yet it is also even economy over a longer horizon. more essential. Most critically, we expect that fiscal intervention will remain a policy In the 25th edition of our Long-Term Capital Market Assumptions tool well into the next cycle. The alignment of monetary and fiscal (LTCMAs), we aim to do just that: to abstract from the challenges policy in the same supportive direction is perhaps the biggest single faced in the very near term and consider the lasting consequences difference in the fabric of the economy between this new cycle and of the COVID-19 crisis, and in particular how the policies adopted to the last one. Capital markets are already feeling the ripples of the tackle the crisis will affect the next cycle. We also consider some of more interventionist actions from policymakers (EXHIBIT 1B). the issues that transcend the pandemic and persistently shape the economic environment. Unlike our macro projections, our forecasts for asset returns include more material changes. Once again, we are downgrading many of Perhaps it will come as a surprise that we expect very few lasting our forecasts for public market returns. The challenges for core consequences for nominal economic activity around the world; our fixed income are especially acute, which in turn prompts us to central forecasts for growth (EXHIBIT 1A) and inflation are very rethink how we construct balanced portfolios. The use of similar to those we published last year. alternatives – to provide income and diversification – is more imperative than ever. However, much like a swan, which appears to glide gracefully across the water while invisibly but furiously paddling below the water’s surface, today’s policymakers – central banks and governments – have been doing the hard work to maintain the economy’s 1 In Q3 2020, the Federal Reserve announced an “average inflation targeting” regime forward glide. that allows policymakers to balance periods where inflation falls below target by letting inflation rise above the 2% target at times. Limited change to potential growth forecasts … ... but big changes to policy have huge implications for asset return forecasts EXHIBIT 1A: PRIOR TRAJECTORY OF LTCMA 10- TO 15-YEAR GLOBAL GROWTH EXHIBIT 1B: CENTRAL BANK BALANCE SHEETS AND FISCAL SPEND AS A FORECAST (2014–21) % OF GDP, 2005–20 Developed markets Emerging markets Global G4 debt % GDP (RHS) G4 central bank assets, in USD billions 5% 25,000 120% 100% 4% 20,000 80% 3% 15,000 60% 2% USD billions 10,000 y/y%, annualized 40% 1% 5,000 20% 0% 0 0% 2014 2015 2016 2017 2018 2019 2020 2021 ’05 ’06 ’07 ’08 ’09 ’10 ’11 ’12 ’13 ’14 ’15 ’16 ’17 ’18 ’19 ’20 Source: Bloomberg, Haver, J.P. Morgan Asset Management; data as of September 30, 2020. 6 LONG-TERM CAPITAL MARKET ASSUMPTIONS A NEW PORTFOLIO FOR A NEW DECADE A LOT GOING ON BELOW THE SURFACE Every new cycle follows a recession, and each recession has its own Essentially, this was a recession that shouldn’t have happened – at character and policy responses, which themselves influence the least, not yet – and one caused by a truly exogenous shock rather contour of growth in the years that follow. The last recession was than an endemic issue or imbalance that pushed the economy over unusual in that it was triggered by a sudden seizure in the supply a cliff.
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