Our approach to expected returns estimates is model driven. We break down asset class dynamics into a long term component (or trend/fair value), mainly related to macroeconomic variables and a medium-term component, explained by economic and financial cycles. Short-term misalignments, linked to market divergence are not considered here for the purpose of this analysis, but are included while noting our tactical asset allocation recommendations.
For the years to come, it seems reasonable to us to bet on the following situation:
lower structural growth than before the Great Financial Crisis;
low inflation, but which is gradually becoming more of a concern with the end of the disinflation/deflation exported by China;
higher interest rates than today, but which remain low by historical standards (the current economic equilibrium justifies lower equilibrium rates than before).
Long term equity returns and earnings growth converge. Long term, equities tend to post returns in line with earnings growth. Divergences can last for long periods, but due to mean reversion, these phases end up in corrections. In current conditions, markets still have some way to go, but unless we see a structural rise in earnings (unlikely), returns should revert to their structural trends.
