By Christopher P. Davis
“Stocks to return 3% over the next decade”
“Fixed income to be treacherous if inflation reignites”
These are the sort of well-meaning click-bait headlines that come around in the fourth quarter as sell side firms and asset managers publish their “Long Term Capital Markets” forecasts looking out over a decade. These reports have many audiences: pensions & insurance companies that have defined obligations to retirees & policy holders, sovereign wealth funds & endowments with perpetual time horizons, and family offices that like to think their time horizon is generational, not just so long as the current staff remains working. As for individual investors and affluent families, the utility of these forecasts is a lot less clear.
Perhaps the simplest fault one can find in these projections is their length – 10 years. Imagine what a forecaster thought in 1925 about what 1935 would bring. Or the change between 1965 and 1975, let alone 1995 and 2005. The intervening events of depression, war, inflation, changing monetary orders, technological change, and global terrorism were not likely to be found in any crystal balls. Even one of the most far-seeing thinkers, Bill Gates, cautions that people overestimate the change in a year and underestimate the change in a decade. Closer to home, consider the changes and unexpected turns within a decade of your own life.
The inputs to many of these capital markets assumptions models are solid and much the same as security analysts consider when evaluating an individual company: economic growth rates, the point in the business cycle, interest rates in relation to long term averages, the valuation of stocks in aggregate, and even the level of concentration in the market. The difficulty comes in extrapolating too far forward and thinking that the future will resemble the recent past.
If you are managing an endowment and need to contribute a percentage of your university’s operating budget each year, such targets may be helpful as you manage to that distribution. The same goes for a pension fund. The multi-asset investor whose goal is to simply make as much money as possible, regardless of the environment, will make allocation shifts more than once a decade in the quest. The investor who may be hurt the most by acting on such projections is the individual, who by temperament might seek a “middle of the road” approach. Seeing stocks as too risky and “projected” to have a low return, they might allocate too much to fixed income locking in a lower rate of return only to miss out on equity gains when the future turned out to be brighter or simply different than anticipated.
Individual investors and affluent families should not be excited nor depressed by these forecasts. If the starting place for stocks is that the index is concentrated and expensive, amid a maturing economic cycle, these reports are simply an advertisement for active management. Higher equity returns might be available by diversifying into cheaper and smaller companies and being cognizant of where the economic cycle stands. It is always dangerous to generalize, but most investors are well served by having a portion of their assets managed to make as much as prudently possible in whatever the environment is. On the flip side, what constitutes a conservative investment does change over time and the right balance between fixed income, real estate, and precious metals will be – just like stocks – dependent on your starting point. Investing in a price-aware way and knowing what you own are sound financial habits, not just once a decade, but every day.
