SIMON BROWN: I am now chatting with John Bilton, Head of Global Multi-Asset Strategy at JP Morgan Asset Management. John, I appreciate the time. You have just completed the 26th Annual Long Term Capital Market Assumptions from JP Morgan Asset Management. Can you give us a brief overview of what the research is designed to achieve, and what were the main findings for 2022?
JEAN BILTON: Sure. And thank you for inviting me on this. Yes, you are right, this is our 26th annual edition – something that we are extremely proud of as an organization. We’ve titled this year’s long-term capital market assumptions “Fading Scars, Lasting Policies” – and that really reflects the ethics of what we’ve looked at.
If we go back two years, to the onset of the coronavirus pandemic, we were all concerned about the long-term economic scars hurting the potential growth rate of the economy, and we expected to see major bankruptcies and layoffs. that would really reduce production capacity. This is not the legacy of the pandemic. Instead, what we’ve seen is that the tools and policies put in place – both fiscal and monetary – to prevent this outcome, are in fact what the legacy of the pandemic will be.
We believe that for the next 10 to 15 years we are going to face a substantial period with significant political support.
So the world we had before – where we only had strong monetary policy, we didn’t have large investment cycles or budget spending, and we had a somewhat imbalanced economy is now behind us.
Go forward [presents] a little more risk of inflation. We are facing a situation where bond yields are likely to be negative in real terms for G4 sovereigns for most of our forecast horizon.
We see a lot of potential in terms of equity returns because we believe this is a decent growth environment, and of course we need to broaden our range of opportunities if we are to be able to deliver the type of return we’ve seen historically.
SIMON BROWN: I understand your point on this – the accommodative policies of support, the responses that have prevented this economic downturn. What do you expect from central bank tapering programs and a potential impact on asset classes?
JEAN BILTON: Well, reduction is obviously a short-term problem compared to where it is now. We expect a decrease in all major central banks over the next year or so, as we operate with a very accommodative policy. So think of this as a normalization rather than a tightening. But, make no mistake, we expect central bank balance sheets to remain a significant force over the next 10 to 15 years. We don’t expect to see a major shrinkage all the time.
So how do we actually think about it from asset markets today? Well, I think first and foremost, if we take the short term, the market has absorbed the idea of shrinking without having the kind of tantrum that we saw in 2013. So I think it has. in fact been relatively well telegraphed. Arguably, central banks have learned from past experiences and have in fact handled it much more easily; but it also indicates what can be expected from central banks.
We believe that monetary policy and decisions are going to be telegraphed much more in advance. We believe that balance sheets will be at least as important as interest rate policy. But remember, even if we see a decrease, we will still be in a world where interest rates – both short term and long term – are likely to be lower than going inflation rates. This means a world where real returns will be negative for bonds… of course if you are a bond holder it means you need to think very carefully about those fixed income holdings.
But if you own another asset, whether it’s stocks or alternatives, your discount rates are actually supporting your cash flow over time. This is the reason why, despite some of the short term noise that we can see around the decrease, we actually think the environment continues to be very favorable.
SIMON BROWN: You mentioned these economic scars created by the pandemic, and that they were not as severe as forecasters had predicted, [with] growth is returning to developed markets. How would you describe the impact on emerging markets in the short and long term, and in particular once the commodities cycle is over?
JEAN BILTON: I think that’s one of the things we need to think about. Back to the commodity cycle: is the commodity cycle coming to an end? We have obviously seen a very big jump in terms of commodity industries over the last couple of years as we have seen the goods market recover significantly with a lot of activity there.
But we believe from our figures that commodities will continue to beat their benchmark, which is global inflation, which implies that there is still an increase, although less in terms of magnitude than this. that we have seen in the past for commodities.
They must therefore be well supported. Furthermore, it should be borne in mind that as we move towards a new green future, renewable and sustainable infrastructure does not build itself; there will be a short-term demand for the commodities. So it may be a bit premature to end a commodity cycle.
How is this reflected in emerging markets? Well the thing to remember is that emerging markets are a very different animal today than they were 10 or 15 years ago. They are less dependent on raw materials. Obviously there are pockets – South Africa of course being one of them [and] Brazil and so on. But, overall, the emerging market in terms of the stock market is dominated by places like China, India, Taiwan, Korea, and the composition of the index in those places is a much more developed market like the big tech sector, increasing exposure to consumers.
So where are we in emerging markets? Well, growth in emerging markets is always greater than growth in developed markets because there is more recovery towards the tech frontier, in our view.
There is reason to expect EM to grow faster than DM, but the differential is smaller than it was in the past.
The returns are potentially still there, but it is clear that the indices themselves are quite different today.
SIMON BROWN: I understand your reasoning. And then, in your opinion, for a final question, to get solid real returns, what does an optimal diversified global portfolio look like against that historic 60:40 equity: bond?
JEAN BILTON: Well, at the end of the day that’s part of the problem. If you go back 10 years, if you look at the 10-year rolling performance of global stocks and US global bonds, you would get 7% or 8%; we’re just not going to see that in the future.
To earn the same amount back, you have to do something different. There are no two ways about it. You’re going to have to take more risks.
What we would say is that because bond yields are so low you are not getting any return from your fixed income component.
While it’s always important to have bonds in a portfolio, what you can’t do is trust them to provide you with a reasonable return; so you put a lot more risk on stocks.
You’re also considering using diversification – what other assets offer you different times of risk – whether that’s liquidity risk, international risk, etc. – and integrate it.
So in the future we can get reasonable returns, but we have to think about the use of illiquidity first – real estate, real estate assets, private equity, etc. as well as your public markets.
We have to think, number two, internationally (markets). Most investors around the world have a certain fondness for the house, but there’s a lot to play in if you look more broadly across the globe.
Then number three, I think we need to be a bit more active because, remember, the returns we’re suggesting – and right now we’re seeing a little over 4% expected return on a 60:40 US dollar. – these returns are just the baseline. This is what you get if you buy in the market but don’t make any active or cycle-aware decisions. So, making some of these active decisions is the last part that we think is important in order to be able to plan and manage to generate higher returns.
SIMON BROWN: We will leave it there. John Milton, Head of Global Multi-Asset Strategy at JP Morgan Asset Management, I appreciate the time.
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