Portfolio Outlook Is the Best Since 2010: JPMorgan's Kelly

The long-term asset return forecasts for "portfolios of all kinds are better today than they have been in a decade," according to J.P. Morgan Asset Management's latest long-term capital market assumption report.

"Opportunities for long-term investors with capital to deploy are the best we've seen since 2010," the report continues. In fact, allowing for a 16% drop in 60/40 portfolio this year and assuming a consistent 7.2% yearly return, a balanced portfolio should recover in about three years, it explains.

"Our forecast annual return for a [U.S. dollar-denominated] 60/40 stock-bond portfolio over the next 10–15 years leaps from 4.30% last year to 7.20%. Over the last 25 years, the rolling 10-year return for this portfolio has averaged 6.10%," the report states.

Still, the JPMorgan team warns that some additional short-term pain is likely in store and that a shallow recession is probably in the cards for 2023. Overall, though, their outlook is one of the most optimistic ever published in the 27-year history of the report, according to several experts — including Chief Global Strategist David Kelly — who met with the press Tuesday in New York.

Other speakers included John Bilton, head of global multi-asset strategy, and Monica Issar, global head of wealth management multi-asset and portfolio solutions.

Headwinds Shift to Tailwinds

While investors are rightly focused on elevated inflation and other near-term headwinds, inflation should cool over the next couple of years, the three speakers emphasized, and longer-term return projections have shifted meaningfully higher.

"Despite near-term cyclical challenges, our inflation forecasts move only modestly higher as we see inflation cooling close to central bank targets," Kelly said. "While entry points are more attractive than they were a year ago, they could get even more attractive if the cyclical weakness of 2022 extends into 2023, as seems likely."

Accordingly, investors need to consider the timing of their entry point, the panel agreed, with a sober eye to how great a decline they can tolerate in the short term.

What's Next for the 60/40?

There's no reason to abandon 60/40 portfolios, Kelly says.

While this year has been brutal for such portfolios, "What is important to understand is that 2022 has been a historically abnormal year, thanks in large part to the persistent spike in inflation that we have seen and the fight to get it under control," he explained.

"Moving forward, there is good reason to believe that inflation can be tamed and that traditional perspectives about stock and bond correlations will be borne out, meaning 60/40 is still a good approach," he added.

Much of the pain felt this year by bond investors has stemmed directly from the fight against inflation — not from some type of fundamental weakness in the bond market itself, Kelly explained. It's highly unusual, from a historical perspective, to see inflation spike so dramatically at the same time that concerns about future growth are quickly driving down stock valuations, he noted.

"We see strong reason to believe that the current spike in inflation, while more durable than many expected last year, is not going to be permanent, if only because of the demonstrated resolve of central banks when it comes to getting inflation in check," Kelly said.

"Our optimistic long-term forecast assumes that key central bankers, such as the U.S. Federal Reserve Chair Jerome Powell, should be taken at their word, meaning they will do whatever it takes to get inflation in check," he said.

Assuming that rapidly rising inflation is not going to become a permanent fixture of the global economy, the basic diversification assumptions underlying the 60/40 approach still hold water, Kelly explained. Plus, over the long term, stocks and bonds should indeed remain negatively correlated, and blended portfolios should also benefit from higher-and-safer income rates, he says.

'Bonds Are Back'

Issar agreed wholeheartedly with these points, noting with enthusiasm that "bonds are back" as an income generation vehicle. Yes investors have seen the book value of bond portfolios fall this year, but they are being compensated with an opportunity to reinvest in bonds that pay yields higher than those seen for a generation, she said.

Now that policy rates have normalized, and done so swiftly, bonds no longer look like serial losers, Issar emphasized.

"Once again, bonds offer a plausible source of income as well as diversification," she said. "Higher riskless rates also translate to improved credit return forecasts, which will help retirement investors."

In the end, given the improvement in forward return assumptions for public markets, a "baseline" 60/40 portfolio may deliver higher forward returns than at any time in more than a decade.

On the equity side, in response to a stronger dollar, global investments may prove attractive to U.S.-based investors, while U.S. investments correspondingly could be less attractive to non-U.S. investors.

According to Issar, Kelly and Bilton, caution is still required, however, as the non-zero potential for a more permanent shift to a more positively correlated environment may limit an investor's capacity to diversify equity risk and may increase volatility.

"As a result, increased exposure to lower volatility credit sectors and diversified alternatives may be needed to balance risk and return at the portfolio level," Issar concluded.