How can portfolios build resilience to AI, inflation and rising deficits?

Zooming out from the day-to-day, we see three themes driving the long-term outlook: economic nationalism, tech adoption and capital rewiring.¹ In our 2027 Long-term Capital Market Assumptions, we take the glass half-full view: we see these trends boosting our return assumptions. Higher earnings and yields push up the projected return for a balanced portfolio by 60 basis points, to 7.00%.² That said, we also see a bumpy and winding path to that endpoint. Investors should understand the changing nature of risk both within and across asset classes. We raise our volatility forecasts and shift our correlation assumptions. The volatility of inflation, rates and equities will likely move higher over our investment horizon. Meanwhile, we expect the stock-bond correlation to be more positive and unstable.

More than just macro shocks: Resilient portfolios should diversify the diversifiers 

A resilient portfolio should lean into opportunities while drawing on diversifiers to cushion the impact of different types of shocks. We think negative supply shocks will occur almost as frequently as demand-side shocks. For supply (inflation) shocks, portfolios need inflation hedges, real assets and gold. For demand (recession) shocks, duration continues to play an important role in portfolios, especially now that forward-looking return assumptions begin with higher rates. 

Investors should also consider non-traditional macro shocks, such as market volatility around the AI theme and/or sudden market dislocations related to capital moving back to domestic markets. In this context, building portfolio resilience requires diversifying thematic exposure. Investors need to be intentional about thematic exposure by analyzing portfolios holistically, with a total portfolio focus and an evaluation of both public and private markets. 

A portfolio optimized using our projected returns will result in an elevated tilt toward the tech adoption theme given higher expected returns, as well as the growing concentration of asset classes to the tech theme. We think that’s a net positive. But an investor looking for less exposure to the tech adoption theme can choose to decrease exposure to U.S. and emerging market equities, as well as financial alternatives, and add exposure to developed market ex-U.S. equities, parts of core real estate and gold.

Portfolio resilience is multi-faceted. Thematic diversification is one way to strengthen that resilience and provide a useful complement to asset class diversification and manager selection.  

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