The New Year has begun in an unsettled fashion with global equity markets suffering heavy losses in the first weeks of trading, leaving investors feeling nervous about the outlook for 2016. At times like these, investors may panic and feel tempted to make significant portfolio adjustments and deviate from their investment plan. Whilst the immediate effect of these emotional moves may not be felt, somewhere in the future investment goals may not be achieved.
So what's the outlook for 2016 and beyond?
We think world economic growth will remain frustratingly fragile, with the six-year-old global recovery continuing at a modest pace, marked by occasional growth scares.
Looking further ahead, we expect weaker inflation, persistent low interest rates and lower growth across developed countries over the next decade compared with pre-GFC levels, due largely to slower credit, productivity and labour force growth.
As economic growth remains subdued, we expect all asset classes to deliver lower nominal yields. However, given the low level of inflation, we still expect fair real inflation-adjusted returns.
Fair wind for equities...
When it comes to global equities, we predict nominal returns centred in the range of 7-10%, and real equity returns broadly in line with historical averages.
Back in Australia, we don't believe equities are overvalued when adjusted for low interest rates. We also predict long-term median equity returns to centre in the range of 7-10%, slightly below the historical average of around 10%.
...more headwinds for bonds
While the US Federal Reserve raised interest rates in December 2015 for the first time since the GFC, further increases are likely to be measured and gradual. So as rates remain low by historical standards, we predict a guarded outlook for bonds and cash. The fixed income market is likely to remain positive yet muted, with median returns of 2.5-3.5%.
So what does this mean for your client portfolios?
Take a total view
While interest rates are likely to remain low for longer, that's no reason to abandon whole asset classes.
Despite lower returns, we encourage investors to look at the role of fixed income from a perspective of balance and diversification rather than outright returns. High-grade or investment-grade bonds can act as ballast in a portfolio, buffering losses from riskier assets such as equities.
The recent drops in share market values are a case in point where conservative bond portfolios remained in positive return territory.
In the figure below, we provide return projections for three typical diversified portfolios - conservative, balanced and growth. We expect below-historical-average returns for the conservative portfolio given the higher allocation to cash and bonds. In contrast, a growth portfolio should deliver returns more in line with historical averages given a higher allocation to equities and property.