Outlook 2025
15 Nov 2024
21 June 2024
Lukas Gehrig, Zurich Switzerland, Quantitative Strategist; Nikola Vasiljevic, Zurich, Switzerland, Head of Quantitative Strategy
Please note: This article is more technical in nature than our typical articles, and may require some background knowledge and experience in investing to understand the themes that we explore below.
The periodic review of our Capital Market Assumptions (CMA) and Strategic Asset Allocation (SAA) is important to ensure that the long-term investment process supports investment decision-making.
This report updates our outlook for key macroeconomic drivers and the anticipated performance of asset classes beyond a typical one-year outlook. Our long-term views cover an investment horizon of five years. For clients requiring a longer time horizon, a ten-year outlook is also provided. Additionally, the report looks at the potential implications for asset allocation, based on our updated outlook.
Last year’s CMA review focused on the potential implications around interest rate hikes, estimating the impact these might have on economic growth and inflation across the globe. Most of our re-adjustments this year reflect how eventful 2023 was for financial markets, and the extension of the forecast horizon, rather than changes in the way we see economies and markets evolving.
At the midpoint of 2024, inflation and interest rates remain high in developed markets (see table). The US, however, has digested the economic challenges of the last 12 months better than other economies and is therefore in a position of relative strength.
This sets up the current review to be about divergence among the world’s largest economies. While Europe is reaccelerating from various mild degrees of recession, America continued to grow without coming to a standstill. We expect the US economy to dip only temporarily below its potential growth rate.
Macroeconomic projections and differences to those in our last CMA review (%)
Real GDP growth | Inflation | Central bank policy rate | ||||
---|---|---|---|---|---|---|
2024 CMA | Change from 2023 | 2024 CMA | Change from 2023 | 2024 CMA | Change from 2023 | |
USA | 2.0 | 0.6 | 2.3 | -0.1 | 3.4 | 0.3 |
UK | 1.2 | 0.2 | 2.1 | -1.1 | 3.3 | 0.4 |
Eurozone | 1.2 | 0.1 | 2.1 | -0.8 | 2.5 | 0.3 |
Switzerland | 1.6 | 0.3 | 1.4 | -0.1 | 1.1 | 0.1 |
Developed Markets | 1.6 | 0.0 | 2.4 | -0.3 | ||
Emerging Markets | 4.0 | -0.1 | 4.1 | -0.3 |
Source: Barclays Private Bank, June 2024
Please note: Forecasts are not a reliable indicator of future performance. The value of investments can fall as well as rise and you may get back less than you invested.
The post-Covid inflation shock has persisted longer than several economists expected. Amid geopolitical risks and a still tight US labour market, inflation remains a threat but does not haunt our economic outlook anymore. As such, inflation is forecast to ease, such that five-year average projections are now within central bank target bands for reviewed developed economies. By contrast, annual price rises in emerging markets are contained, due to China’s low inflation expectations in the coming years1.
Our inflation forecast contains considerable upside risks, such as a potential surge in commodity prices as a result of geopolitical tensions, much higher energy prices, the possible impact on inflation of a scramble for resources needed for two things – success in the green transition, or management of an AI revolution. That said, a relatively slow economic recovery in many parts of the world could keep a lid on the effects of such risks.
We expect central banks to be wary of cutting interest rates too much, or too quickly, in such a way that then requires more aggressive tightening later on. In the absence of a significant recession, easing is likely to be administered gradually and only towards the long-term anchor of the neutral rate of interest. We estimate that this rate lies above 2% for the US and UK, and below 2% for the eurozone and Switzerland.
As a consequence of the gradual rate-cutting cycle, expected returns for cash and short-term bonds over the next five years are relatively high, compared to those achieved over the last ten years (see chart).
Rolling five-year average returns for cash instruments, adjusted for inflation, and five-year ahead projections (markers). All figures are annualised. Estimates cover the period from 2024 to 2028
Relative to our previous CMA review, expected returns have decreased across the board, with only cash rates and US government bonds being notable exceptions.
Changes in the forecast performance of fixed income assets reflect the valuation gains seen over the last year, and so the lower starting yield for European bonds now. The changes in the outlook for equities come down to higher valuations, which now weigh on the long-term performance potential, and lower-return contributions from dividends and share buybacks.
The diverging macroeconomic prospects of the developed markets are most visible in government bond return forecasts, which are most directly impacted by the projected easing of policy rates and the repricing that has already occurred in some markets.
Due to the higher yield at the beginning of the forecast horizon and the expected valuation gains as yields decline, US government bond returns have been increased to 5.6% over the review period. European government bonds, however, have already realised valuation gains from falling yields, such that the total-return outlook is downgraded to 4.9% and 3.0%, for the UK and the eurozone respectively (see chart). For Swiss government bonds, and also due to the long duration, valuation is likely to be a significant drag on their returns.
Mirroring the divergence in yields and valuation gains from government bonds, expected returns for investment grade bonds – in excess of cash – are low by historical standards for eurozone countries, and relatively strong for the US and UK. Investment grade spreads in the latter two countries are forecast to increase slightly, while remaining stable in the eurozone and Switzerland.
Meanwhile, the anticipated excess returns for high yield bonds are relatively low. While US high yield is likely to suffer from the projected dip in economic growth, European high yield returns – like those for investment grade – have been marked down due to their recent realised valuation gains.
Annualised projections for total returns (bars) and the expected, regime-dependent, volatility (markers). Estimates cover the period from 2024 to 2028
With weaker growth expected in the global economy over our forecast period, equity markets are expected to post lower returns relative to those seen in last year’s CMA. The same holds for developed real estate investment trusts (REITs).
Overall, equity returns could be around 1.0% lower on an annualised basis, depending on which market is considered. However, earnings growth prospects remain promising, with reaccelerating economic growth in Europe and only a temporary dip likely in US output. Still, at 6.4%, expected US equity returns are low in an historical context. A mix of slightly elevated valuations and somewhat muted dividends and share buybacks – typically a significant driver of US equity returns – account for the weaker US performance.
By contrast, UK shares could top the equity returns in our covered developed markets over the five-year review period at 7.0%, which would be close to their long-term average.
Turning to REITs, anticipated returns have also been downgraded to 8.0%. That said, this would still be around their historical average. In addition, the asset class is expected to outperform equities over the forecast horizon, mostly due to anticipated valuation gains. These are mainly anticipated to be seen in the US, supported by a well-ordered transition to a lower, neutral, interest rate environment, without significant repercussions for the housing market.
Forecast returns for the commodity aggregate have been trimmed to 1.9% over 2024-2028, mostly as a reflection of the likely drop in cyclical demand for resources in the first half of our five-year horizon.
Energy prices are expected to plateau, before gradually drifting lower, towards the end of the investment horizon. Industrial metals, on the other hand, should support commodity returns as emerging market and European economies accelerate. By contrast, food prices seem likely to recede over the period, dodging further geopolitically induced shocks.
Hedge fund performance typically improves with cash rates and equity returns. Cash returns are likely to be high relative to those seen in the last 25 years. But equity and bond returns are now lower compared to our 2023 CMA forecasts, limiting potential portfolio gains for large parts of the investable hedge fund universe. This leads us to lower our expected returns for Alternative Trading Strategies (ATS) and hedge funds slightly to 3.8% and 6.3%, respectively.
The CMA assumptions are complemented by expected volatilities and correlations. The framework revolves around our multi-asset class risk-on, risk-off indicator (RoRo). Market volatility has continued to fall over the last 12 months, which is also captured by our multi-asset class metric (see chart).
Statistical multi-asset class (MAC) risk indicator based on the CMA investment universe. Risk-on and risk-off are split based on the median reading seen since starting in 2000
While market volatility might appear to be low, inflation is still elevated; the Ukrainian and Middle Eastern conflicts are far from resolved; and US rate cuts remain outstanding. As such, more weight continues to be assigned to risk-off periods, at 60%, in our volatility and correlation computations.
Due to more recent observations entering our sample, the expectations for the key long-term equity-bond correlation were nudged up from -0.21 to -0.16 for US government bonds versus US equities, and from -0.02 to 0.01 for their European counterparts. This higher correlation reinforces our view that equities and bonds act more as substitutes for each other, rather than being complementary in a portfolio context.
Anticipated returns might be lower for most assets over the five-year review period, with the exception of cash and US government bonds. However, the decrease is commensurate with each asset class’ risk. On a risk-adjusted basis, our outlook is relatively stable. As such, the optimal asset mixes remain steady for all risk profiles and our SAA is unchanged.
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Please note that our CMA assumptions exclude Argentina, due to the fact that the country’s hyperinflation would distort the weighted emerging market average inflation projection.Return to reference