David Lebovitz: Welcome to the Center for Investment Excellence, a production of J.P. Morgan Asset Management. The Center for Investment Excellence is an audio podcast that provides educational insights across asset classes and investment themes. Today's episode is on the 2024 long-term capital market assumptions, smarter portfolios for a world in transition, and has been recorded for institutional and professional investors.

I'm David Lebovitz, Global Market Strategist and host of the Center for Investment Excellence. With me today is Grace Koo, a Portfolio Manager in our Multi-Asset Solutions business. Hi, Grace. Welcome to the Center for Investment Excellence.

Grace Koo: Thank you, David. Happy to be here.

David Lebovitz: Well, we are particularly excited to have you here for the conversation today. When I think about 2023 so far, we've seen another big move higher in interest rates. We've seen economic activity that's been more resilient than expected. We've seen both politics and geopolitics flare up from time to time. And I think this has created a very challenging macro backdrop for investors to think through.

And so, it's great that you're here today to talk a little bit about our long-term capital market assumptions, because I think these are really the times where focusing on the long-term can be a recipe for success. So, with all that said, if we want to dive right in, we've produced the LTCMAs for a number of years. We always release them in the fall. Last week, there was a lot of excitement about the opportunity in traditional stocks and bonds and bonds were back, but what are some of the themes of this year's assumptions?

Grace Koo: So, we are very excited to be doing this for the 28th year at this point, and this year's theme that we have in the capital market assumptions is, smarter portfolios for a world in transition. Clearly, a lot is happening in the macro environment currently. There is transition in the economy. There is the policy transition that we see moving from a negative interest rate to more positive and now more positive real rates as well.

And also, more importantly, in terms of some key secular drivers, we do see technology being in transition and also climate being also in transition. So, with so much changes in the world, what we are actually looking at in the asset market perspective is that the 60/40 that we have hit the table with, pounded the table very clearly that is back last year, continues to be a very excellent starting point.

If you look at the forecasted return, we are looking at a 7%, 60/40 return. It is slightly lower than last year by 20 basis points, but if you step back, 7% over a long run is a very attractive proposition. But then, one shouldn't stop there. One of the things that we are looking at as well is suggesting investors to, one, not shy and hid in the cash asset, but one needs to extend.

If you think about the forward-looking expectations of returns, if one stays within cash for the next 10 years, you may have 33% returns. But if you actually invest in a 60/40, you can reach towards almost 100%. So, you're leaving a lot of returns on the table if you don't actually reach out. And, more importantly, one can even go further and include alternatives as well.

So, as the capital market assumption comes together, we have definitely this theme about expanding the opportunity set and also enhancing with active. As we build in more of these different opportunity sets, active management becomes a call, clearly within alts, but also in public markets, within active equities, within a multi-asset context, in asset allocation, are all very good ways for us to manage this transition that we speak about earlier.

David Lebovitz: Well, that was awesome, and thank you for the 20,000-foot view. I know we're going to peel back the layers of the onion around some of the assumptions themselves across equities, fixed income, alternatives, but let's start with the outlook for growth and inflation. So, we've obviously been in this world of inflation unlike levels a lot of us have ever seen. What's the long-term thinking about the outlook for growth and prices?

Grace Koo: So, on that front, it's clearly something that is very important in our conversation as we develop this long-term view. On the growth front, what we're looking at is actually better-developed market growth. We spoke about the technology transition, and actually, one of the key themes coming out is the productivity upside we see from the AI development and automation.

And that, we feel, is going to boost the developed markets by 10 basis points, which can be conservative at this point, but I think if we are right on that, it will be a journey that will likely going to persist and move forward. And there are other elements that are clearly on the policy perspective that can even boost growth further.

For example, that energy transition we spoke about in European countries, that can give it another boost as well. So, for developed market growth, we do actually see there is some upside compared to prior years. In the inflation perspective, it's clearly something that we saw spike in prior months and years, but then I think what we have seen is, we turned a corner.

We are now moving towards a decline, and that will likely persist, especially in the U.S. that we have saw pretty good, solid transition towards lower inflation, towards what we feel is more fair in the long term. But that transition itself is also bringing some nuance in terms of international aspects in the inflation front.

Clearly, Europe was in a disinflationary environment for quite a while. We do think they're going to come out of that hole. And more importantly, is Japan. Japan is clearly now finally, I think with more convincing evidence, that it is turning a corner towards more positive inflation.

And I think all these, on the growth fronts with more positive developed markets, equities aspect in the revenue side is going to be positive. And also, on some of this inflationary normalization, it's going to help us get more opportunities in the bond markets as well.

David Lebovitz: Well, let's stick with fixed income since we just landed on that point. Last year, the story was that bonds are back. One could argue that bonds are still back. So, how have the fixed income assumptions changed over the past 12 months?

Grace Koo: That's actually a core aspect that we would like to highlight is, despite what we have experienced another year of volatile bond returns, on a forward-looking basis, we do find bonds attractive. If you look at where the yields are at this point, with the inflationary discussion that we just have and growth a little higher as well, what we are looking at is a cycle-neutral expectation where the bond market yields are slightly higher than last year.

And that actually helps us build a very robust return profile. And so, if you look at a comparison of cash, we spoke about cash not necessarily being a good long-term investment. And that's a core theme coming out, because we do not believe the Federal Reserve will sit cash rate at the current level for 10 years. It may stick around with us for a number of months, a little longer than we expected, but definitely, it's not something that we expect at this point that policymakers will keep at that level for a long term.

So, with that backdrop, what we actually see is that duration premium is very attractive. What we mean by that is, one should extend the duration in these levels as yield actually reset higher. And so, the entry point is very attractive. And on a long-run perspective, you're looking at bond returns in the fall handle. If you're looking at very long duration asset, it might be in the 5% handle, and these are extremely attractive for a relatively low-risk investments.

In addition to that, credit is another area that we suggest investors to venture into just because I think we get overly concerned about near-term recession risk. But as we take a deep dive into the underlying credit quality, the actual recovery, and default rates that are likely going to occur in this horizon, they are pretty well contained. And we do feel the asset continues to be compensated and generate pretty decent returns for investors.

David Lebovitz: Awesome. Well, so clearly there's an opportunity in fixed income, and I would reiterate the points that you made, which is that there's huge reinvestment risk around holding cash, and arguably duration does look more attractive today than it has in quite some time. Let's go to the risk side of the book and talk a little bit about equities.

Everybody came into this year thinking recession was upon us, equity markets would struggle, and here we are, no recession and S&P up more than 10%. And so, how have the equity assumptions changed both in the U.S. and abroad as we look across the next 10 to 15 years?

Grace Koo: So, I think one of the expectation coming into equity forecasting is that we have a very healthy equity year this year. And so, one would expect that our return forecast at this point would be lower. So, we directionally agree, but if you actually look at the levels themselves, it continues to be very, very attractive.

For example, in U.S. large-cap, we are still expecting a 7% return of S&P 500 over the next 10, 15 years. And this very robust return came from the fact that there is this transition that we expect in the technology world. And the international side are even more exciting. So, international equities in our book includes everything from European equities, Japanese, emerging markets, et cetera.

And I would like to draw your attention to European equities and Japanese equities in particular for two reasons. One is, we did discuss the fact that they are actually likely going to experience stronger growth than before. And the other aspect is actually on the currency perspective. They are actually markets where we are supported by currency trends.

Dollar strength has softened a touch compared to last year, but there's still room for us to actually expect international currencies such as the euro and yen to rally against the dollar in this horizon. And so, they will provide additional return on top of what we looked at. So, if you look at the EAFE complex in dollar investors' view, we are looking at return in a 9% handle, which clearly is very attractive as a diversifier in addition to US equities.

So, one can question, where are we actually going to fund this investment from? We are not necessarily suggesting investors to fund them from U.S. large-cap, because I think there's quality, there's growth, which is secular, and we do actually like the market. What we are seeing is, we are actually a little less enthusiastic about emerging markets.

Emerging markets have been going through a secular downtrend, and that's likely going to continue as well. So, with the emerging markets and developed markets gap narrowing, we do think that would be a natural funding source to consider.

David Lebovitz: Excellent. Well, I think we've all been waiting a long time for somebody to say something positive about Japanese equities, and it sounds like there's a nice opportunity there, as well as in Europe when we look across the longer term. And so, maybe just one final question for you today. So, we've been talking about growth and inflation and the implications of that macro backdrop for publicly traded stocks and bonds.

We've worked on this together over the past couple of years. Alternatives have been a very significant theme. And so, can you talk a little bit about, in an environment where the 60/40 portfolio is back, one, do investors still need alternatives? And two, where are the greatest opportunities?

Grace Koo: Definitely. Alternatives is something that, on a return perspective, as we discussed, public markets is generating 7%. So, alternatives still provides attractiveness in two areas. One is diversification. As we discussed, part of the macro backdrop is this transition. There's a lot happening at the same time in the short-term horizon.

And as we transition, this path may not be as smooth as we would like. And that's where alternatives can play a pretty good role in terms of smoothing the ride that investors are likely going to experience. And that itself is worth a lot. The other aspect is, we discussed a 60/40 being an excellent starting point, but we also know bonds are a good hedge and protection for more growth type of shock.

However, there are other types of shocks in the market. There can be inflation shock. There can be geopolitical risk. And so, having a diversified portfolio that a core anchor will be in alts, will be quite helpful. And in addition to that, as we were discussing, the active management aspect can also play a core role.

We need investments to be a little bit more dynamic to respond to the market conditions. So, active equities, asset allocators in a multi-asset context can clearly also benefit investors in this long run.

David Lebovitz: Excellent. Well, this was fantastic. Thank you so much for joining me, and we're looking forward to having you back again sometime soon.

Grace Koo: Thanks for having me.

David Lebovitz: Thank you for joining us today on J.P. Morgan Center for Investment Excellence. If you found our insights useful, you can find more episodes anywhere you listen to podcasts and on our Web site. Recorded on October 16th, 2023.

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JPMAM Long Term Capital Market Assumptions: Given the complex risk-reward trade-offs involved, we advise clients to rely on judgment as well as quantitative optimization approaches in setting strategic allocations. Please note that all information shown is based on qualitative analysis. Exclusive reliance on the above is not advised. This information is not intended as a recommendation to invest in any particular asset class or strategy or as a promise of future performance. Note that these asset class and strategy assumptions are passive only–they do not consider the impact of active management. References to future returns are not promises or even estimates of actual returns a client portfolio may achieve. Assumptions, opinions and estimates are provided for illustrative purposes only. They should not be relied upon as recommendations to buy or sell securities. Forecasts of financial market trends that are based on current market conditions constitute our judgment and are subject to change without notice. We believe the information provided here is reliable, but do not warrant its accuracy or completeness. This material has been prepared for information purposes only and is not intended to provide, and should not be relied on for, accounting, legal or tax advice. The outputs of the assumptions are provided for illustration/discussion purposes only and are subject to significant limitations. “Expected” or “Alpha” return estimates are subject to uncertainty and error. For example changes in the historical data from which it is estimated will result in different implications for asset class returns. Expected returns for each asset class conditional on an economic scenario; actual returns in the event the scenario comes to pass could be higher or lower, as they have been in the past, so an investor should not expect to achieve returns similar to the outputs shown herein. References to future returns for either asset allocation strategies or asset classes are not promises of actual returns a client portfolio may achieve. Because of the inherent limitations of all models, potential investors should not rely exclusively on the model when making a decision. The model cannot account for the impact that economic, market, and other factors may have on the implementation and ongoing management of an actual investment portfolio. Unlike actual portfolio outcomes, the model outcomes do not reflect actual trading, liquidity constraints, fees, expenses, taxes and other factors that could impact the future returns. The model assumptions are passive only—they do not consider the impact of active management. A manager’s ability to achieve similar outcomes is subject to risk factors over which the manager may have no or limited control.