Key Points
We make only modest year-over-year changes in our volatility and correlation forecasts. But we also see a wider range of potential outcomes, with significant implications for asset allocation.
Higher growth, strong investment and higher rates provide a relatively healthy and stable backdrop for most risk assets. This year, we forecast elevated inflation risks and anticipate increased interest rate volatility due to fiscal activism. The shift will have a significant impact on the broader investment universe.
Among the key takeaways for portfolio construction:
- Expect greater volatility in short-term stock-bond correlations and a wider range in correlations over the long term.
- Higher nominal yields allow core bonds to offset the impact of growth shocks on portfolios and deliver more meaningful total return and income over time.
- Active management and alternatives can play key roles in mitigating inflation risks and potentially boosting risk-adjusted returns.
From “lower for longer” to “healthier foundations”
The next decade’s portfolio needs to look different from the prior cycle’s. “Lower for longer” has been replaced by “healthier foundations,” which come with new opportunities and risks.
The opportunities are clear. Income is now less scarce. The shift to positive real rates presents a favorable starting point for assets that have repriced, such as core bonds and U.S. and European real estate. Higher, healthier corporate earnings support equity returns despite starting valuations.
But risks remain. Geopolitical risks are heightened. Monetary policy may be constrained from acting as a buffer against financial volatility amid elevated inflation risk. Less stable asset class correlations underscore the need to include a range of portfolio diversifiers. Note, too, that some current market imbalances may reverse somewhat over the next few years.
In short: This is no time for an autopilot portfolio strategy.