Capital Market Assumptions 2024

Towards a reordering of asset class profiles

Equity returns are expected to be marked by moderate earnings growth and declining valuation multiples. Valuations dampen our expectations for equity markets, particularly in the United States. Government yields have shifted lower and closer to our equilibrium level, resulting in a decline in expected bond returns. The current market environment remains highly volatile, with significant  fluctuations that can also impact the longer-term horizon. Expectations for high-quality credit are also trending downward, as credit valuations echo the negative shifts originating from government yields.

Risk/Return Trade off

The capital market line remains flatter than historical norms, confirming that it can be challenging to reach high return targets using only liquid assets. Real and alternative assets need to be considered for allocations with a more aggressive risk profile, due to their diversification and return-generation features. In addition, fixed-income assets are fundamental to guarantee stable income in multi-asset portfolios.

Return Contributions

The ten-year outlook for government bonds has deteriorated, primarily due to lower interest rates over the past quarter. For developed market (DM) government bonds, this change is largely attributed to less favourable valuations, with a smaller contribution from lower carry, particularly in the United States and both euro core and peripheral markets. Meanwhile, the decline in expectations for Chinese government bonds is primarily driven by lower carry.

The downgrade in expectations for credit assets primarily stems from a combination of less favourable valuations on both the government yield and credit spread fronts. Within the high-yield space, expected returns remain notably tight. The most substantial change occurred in emerging market hard currency (EM HC) debt, where expected returns decreased more than half a percentage point, driven by less favourable valuations and lower carry.

The main factor influencing the differences in expected returns compared to the previous quarter is predominantly the valuation component, while estimates regarding EPS growth have been only slightly revised down. The recent rally in equities across Asia ex-Japan and China has led to a negative revision in expected returns for these markets. Expensive valuations -- only marginally offset by a benign growth outlook -- still represent a headwind for our US equity long-term scenario. Conversely, Japan is expected to recover, driven by more favourable valuations.

Strategic asset allocation

From an asset allocation perspective, and in light of last year’s strong comeback, we continue to see fixed income as a key engine for portfolio returns, in particular for investors with a moderate risk profile (around 6% volatility target).

Given the higher equity volatility compared to recent decades, investors will need to seek additional sources of diversification, such as Emerging Market Debt.

Real and alternative assets will be key to enhance portfolio risk-return profiles, deserving around 20% allocation for dynamic risk profile investors (around 12% volatility target).

Delays in climate policy and rising geopolitical tension point towards a disorderly transition. The higher costs of the transition will be deferred to later years. The overall transition path is getting riskier as delays increase physical risks. Productivity gains from AI may help to marginally offset some of the economic impact of the transition. We expect AI adoption to be gradual as social and energy costs will also need to be assessed.

Growth and Inflation paths