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Investment markets past the sweet spot

Asset manager Robeco has issued an outlook for investment markets for the next five years, forecasting that returns for the major asset classes will be below long-term averages.

Robeco says: “All good things must come to an end. The length of the current business cycle upswing, which is already above average, gradually leads to growing and eventually unsustainable imbalances. In particular, the leverage in the world economy, which is already high, continues to increase.”

It says investors should focus on downside risk but remain patient and reduce exposure to recession-prone asset classes gradually, as stretched valuations in equity and fixed income eventually breed volatility in both.

Robeco is predicting that developed market equities will grow by 4 per cent a year over the five years to 2023 and emerging markets equities by 4.5 per cent.

Developed market government bonds will fall by an average of 0.25 per cent a year, while emerging markets government debt will rise by 3.75 per cent a year. The global REIT market will rise by 3.25 per cent a year.

“Two bright spots, in terms of relative valuation, are emerging markets debt and commodities,” it says.

While its view is that valuations for every major asset class look overstretched, there are still positive risk premiums to be harvested in this late-cycle environment.

“Opting for a more defensive portfolio is often the default solution. We advocate adopting a patient approach. There are still opportunities to harvest risk premiums in the major asset classes.”

Despite having moved past its sweet spot, the global economy is still in relatively good shape. Growth worldwide is expected to remain solid, albeit unexceptional.

There is still no recession in sight. This may be due to the gradual nature of the upswing. We have yet to see many of the excesses that often presage the onset of economic contraction. Another factor is the very gradual normalisation of monetary policy.

“Although the probability of negative returns is high, we think there is an even greater probability that returns will remain in positive territory on a five-year horizon,” Robeco says.

“On a five-year horizon, we are likely to experience a US recession at some point. The US authorities will probably let the economy grow above its potential by implementing a pro-cyclical policy mix that will ultimately provide unsustainable due to rising inflationary pressures and public debt levels.

“The debt situation in the west’s major economic blocs is unlikely to improve in the next five years. The US is engaging in a large, unusual pro-cyclical policy experiment, which will result in a government deficit exceeding 4.5 per cent GDP next year.

“Despite all the talk of deleveraging, sovereign debt ratios in the major western economies have generally continued to rise.”