Looking ahead

Intermediate projections of the economy and capital markets – five-year outlook from 2020 to 2025

UBS Asset Management Investment Solutions

Our five-year (2020-2025) expectations in brief

UBS Asset Management’s Investment Solutions team conducts ongoing macroeconomic research to develop our baseline five- and 10-year return expectations. Drawing on the breadth and depth of expertise provided by more than 100 professionals and an over-36-year asset management track record, our capital market expectations quantify risk/return expectations for a broad set of asset classes, incorporate current market and economic conditions and provide a key component for modeling a portfolio’s strategic asset allocation.

Our last publication highlighted our June 2019 assumptions. Since then, equities ended the decade with an admirable 10-year record and momentum continued with new highs into February.

Then the pandemic hit and the equity markets dropped more than 30% before rallying sharply. Government bond yields across all maturities declined in the US--which lowered expected return in local terms. Credit markets have had surprising ups and downs, but are still at relatively wide levels going into the end of May.

The main updates in our five-year capital market assumptions compared to our mid-2019 report are:

  • Expected equity returns in nominal terms are higher, as valuation is improved.
  • Government bond yields are even lower, so expected returns are lower. European yields did not drop as much as US yields, but were lower to start with.
  • In general, we lowered expected 10-year yields in developed countries in 2025 by 0.4% to 1.1%. This has offset some of the drop in yields in projected returns.
  • Credit spreads are higher due to higher default risks, but returns are more attractive relative to governments. They bottomed out in early January 2020 before ballooning late in the first quarter of 2020. They tightened significantly in April and into May.
  • The dollar appreciated against most, but not all currencies. Emerging markets had extremely large depreciations (Brazil -29.2% for example). In general, we view the dollar as overvalued against both developed market and emerging market currencies.

Our approach to capital market assumptions

Capital market assumptions (CMA) are critical inputs in designing an investment strategy that will help investors meet specific objectives. A pension plan, for example, has liabilities with certain wage, payout and inflation assumptions; an endowment may plan for distributions based on university budget growth; or a family office may have income and real growth objectives. Ultimately, the CMEs must have an economic logic and consistency behind them that tie into the larger setting that investors face.

We produce long-term, or 'Equilibrium,' assumptions (average return for an asset class over the next 30-40 years, for the purpose of setting general benchmarks), and Baseline expectations covering five- and 10-year returns, for the purpose of building strategic asset allocations. We update Equilibrium and Baseline assumptions quarterly. We rely on shorter term catalysts—such as earnings revisions, manager positioning, market stress and momentum—to set tactical asset allocation views in portfolios.

We call our long run assumptions Equilibrium because we assume that economic and financial variables ultimately regress to an internally consistent regime around long-term Equilibriums. Our Baseline process incorporates current valuations, market conditions and key forward-looking inputs to generate five- and 10-year expected returns by asset class and region. It is important to note that Baseline forecasts should be taken as measures of tendency rather than point estimates, and can be subject to considerable swings in the five-year period as the economic and market cycle progresses. Our Baseline expectations are used to design and evaluate existing strategic asset allocations.

Valuation is an important component of our Baseline process. Valuation focuses on the deviation of asset prices from their intrinsic value; well established as a key driver of returns over multi-year periods1. When assets are undervalued they tend to be set for a period of strong performance, and when they are overvalued they typically lag, though timing may vary. For example, investing in US large cap growth equities in the late 1990s or long-dated bonds in the 1970s would have been ill-advised. Forward-looking inputs may vary by asset class but generally include inflation, economic and earnings growth, cash yields, 10-year government bond yields and default and recovery rates for investment grade and high yield bonds. We offer direct estimates of value on 11 equity markets, 14 fixed income markets and 33 currency markets. We can use these to determine some broad measures of global expectations.

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