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Summary Most asset managers have 10-year expected returns of 6% for stocks, 2% for bonds, and 2% for inflation. For my strategic outlook, I am monitoring inflation, corporate margins, and stock buybacks. For my tactical overlay, I am monitoring earnings momentum and economic momentum. Assumptions about expected returns have a big impact on financial planning: Investors should check the capital market assumptions used by their financial advisor, robo advisor, or online retirement calculator. I recently reviewed the long-term capital market assumptions (CMAs) for five leading brokerage firms and wealth managers. I also looked at the CMAs for the top private and public pension plans. I believe these are a reasonable proxy for market expectations. To keep things simple, I focused on expected returns for a 60/40 portfolio over the next ten years. This exercise led me to create my own set of CMAs, and the attached PDF at the end of this article has a slide deck with links to the original sources. (Readers may wish to review the slides first, since this article merely breezes over the main points.) Expected Returns I agree with consensus, and I expect: A 4.4% return from the 60/40 portfolio over the next ten years. A 6% return for stocks, using the SPDR S&P 500 ETF Trust (NYSEARCA: SPY ). A 2% return for the iShares Core U.S. Aggregate Bond (NYSEARCA: AGG ). Inflation of 2%. These expectations closely align with the forecasts from firms as varied as JPMorgan (NYSE: JPM ), AQR, and Charles Schwab (NYSE: SCHW ). The range of expectations is surprisingly narrow and reasonable. Public pension plans, on the other hand, are too optimistic. I suspect that political pressure prevents public plans from reducing their assumptions for expected returns. Lower returns would increase pension liabilities, and this may result in higher taxes. (Good luck with that!) Attractive Strategies In this environment, investors will have to work harder for less: Low expected returns for beta also suggest low expected returns for alpha. (Low forecast returns also suggests continued pressure on fees throughout the asset management industry.) In this environment, I believe that attractive investment strategies include: Income : Bond ladders, annuities, and covered call strategies Diversification : Managed futures, hedge fund strategies (liquid alts and traditional alts) Return Enhancing: Private equity, UK equities, high yield bonds, and Asia-Ex Japan (though that looks like a crowded long-term trade) Tactical Overlay Long-term assumptions help determine my strategic outlook, but my tactical outlook depends on current valuations and market conditions. My asset allocation process uses a tactical overlay that allows the defensive use of cash, and I attempt to mitigate drops of more than 20%. Right now, the catalysts for a tactical overweight in equities would be lower valuations. (I added to equities in August.) The catalyst for a tactical underweight would be negative momentum in either the economy or corporate earnings. The key factors I’m watching now are inflation, corporate margins, and stock buybacks. A Word on Robo Advisors Automated portfolio construction solutions such as Wealthfront and Betterment make sense for investors who are accumulating assets: Robos offer convenient, low-cost, long-term diversification. But robos are usually limited to an algorithm based on historical data and Mean Variance Optimization. Most algorithms do not change based on current market valuations or current market conditions. After all, if robos changed the assumptions that drive their asset allocation process, they would not be robo advisors – they would be active managers. The static nature of the algorithms used in robo advisors makes me worried about bubbles and crashes. Obviously, the assumptions used by any automated tool will determine the outcome, so investors need to do their homework. I give an A+ to Charles Schwab for the transparency of their CMAs, which are available through a link on their retirement calculator . In either case, investors cannot blindly rely on an automated solution without understanding the assumptions behind it. RBI Capital Market Assumptions Scalper1 News
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