- Low and falling investment yields from most major asset classes point to a constrained medium-term return outlook.
- For a diversified growth mix of assets, the medium-term return potential is around 6.4% on our projections.
- The Australian economy remains in good shape and is still resilient to global negative shocks.
The forces shaping the global outlook—both those operating over the short term and those operating over the long term—point to subdued growth for 2016 and a gradual recovery thereafter, as well as to downside risks. These forces include some new possible shocks; ongoing realignment; demographics and the evolution of productivity growth; as well as non-economic factors, such as geopolitical and political uncertainty. The subdued recovery also plays a role in explaining the weakness in global trade and persistently low inflation. In this article, we explore the medium-term return potential from major assets and the implications for investors.
The forecast: Medium-term returns will remain sluggish
Figure 1 presents AMP Capital’s projections for medium-term returns across a range of asset classes. Combining the return projections for each asset indicates that the implied return for a diversified growth mix of assets is 6.4% p.a. We anticipate that growth will pick up from 2017 onward, on account of the gradual normalisation of macroeconomic conditions in several emerging markets experiencing deep recessions and the increasing weight of fast-growing countries in developing economics.
The downside risks to our medium-term return projections are referred to endlessly by financial commentators: namely that the world is plunged into another recession or that investment yields are pushed up to more normal levels causing large capital losses. The upside risks are (always) less obvious but could occur if global growth improves but inflation remains low, which could see a continuing search for yield further pushing up capital values.
Figure 1: Medium-term (5-7 years) return forecasts
# Current dividend yield for shares, distribution/net rental yields for property and five-year bond yields for bonds.
* The Australian dividend yield is net/grossed-up for franking credits
^ Columns may not add precisely to the total due to rounding
** Traditional balanced growth portfolio comprising of approximately 80% growth assets and 20% defensive assets
Source: AMP Capital
Several themes are allowed for in our projections: slower growth in household debt; the backlash against economic rationalist policies of globalisation, deregulation and small government; rising geopolitical tensions; aging and slowing populations; low commodity prices; technological innovation and automation; the Asian ascendancy and China’s growing middle class; rising environmental awareness; and the energy revolution. Most of these themes are constraining nominal growth and hence investor returns. However, technological innovation is positive for profits and some of these themes point to inflation bottoming.
Implications for investors
In this environment, investors should have reasonable return expectations. A dynamic approach to asset allocation may be a way to enhance returns when the return potential from investment markets is constrained. The combination of low investment yields and constrained GDP growth and low inflation means investors should focus on assets providing decent sustainable income as they provide confidence regarding future returns.