2024 Q2 Capital Market Assumptions
Overview
The global economy remains resilient even as major central banks maintain elevated policy rates to bring inflation back toward their targets. Global GDP growth is expected to moderate slightly in 2024 to 2.8%, down from 3.1% in 2023. Despite the healthy growth environment, inflation appears to be tracking toward central bank targets although the last mile is proving to be a bit stickier than initially expected. Against this backdrop the Multi-Asset team’s Q2 2024 forecast includes:
- An annualized nominal 10-year return for Global Equities of 7.0%, a decrease from the forecast of 7.1% for the first quarter of 2024. The small forecast decrease is primarily attributable to less favorable valuations following an 8.3% advance in Global Equities in the first quarter of 2024.
- Global sovereign interest rates moved broadly higher in the first quarter of 2024 as expectations for global central bank rate cuts were pushed further out into 2024 amid a resilient global economy and still stubbornly high inflation. The long-run forecast for hedged Global Aggregate Bonds is 4.0%, a small increase from last quarter’s forecast.
- The team’s forecast return for a balanced portfolio of 60% Global Equities unhedged and 40% Global Aggregate Bonds hedged is 6.2% annually over the next 10 years, which is identical to the forecast at the end of the first quarter of 2024.
Note: Forecasts may not be achieved and are not a guarantee or reliable indicator of future results
Summary
Q1 2024 Developments Informing Our Long-Term (10-Year) Forecasts:
The global economy remains resilient in early 2024 even as major central banks maintain elevated policy rates to bring inflation, a dominant concern for much of 2023, back toward their targets. Global GDP growth is expected to moderate slightly in 2024 to 2.8%, down from 3.1% in 2023. Economic activity in the US appears solid, while Japan and the Eurozone are growing more moderately. China continues to post slower but still solid GDP growth while growth in other emerging economies has been strong. Despite the healthy growth environment, inflation appears to be tracking toward central bank targets although the last mile is proving to be a bit stickier than initially expected.
The near-term growth outlook for the US remains solid with economic data continuing to surprise on the upside. Labor market strength, evident in robust jobs growth, is helping the economy weather the impact of the Federal Reserve’s (Fed) rate hikes. Eurozone economic growth stagnated toward the end of 2023 with widening divergence among economies. Despite narrowly missing a slip into a recession for two consecutive quarters in the second half of 2023, Japan is expected to post moderate growth in early 2024, driven by improving consumer sentiment and strong wage growth prospects following recent trade union wage negotiations. Our 10-year forecast for GDP growth in developed economies is modestly higher, driven primarily by the US, with Europe providing a negative offset.
On the inflation front, expectations are for a significant decline from last year’s levels after both G7 headline and core inflation pulled back sharply from their 2023 peaks. Although these expectations are partly an extrapolation of those declines continuing into 2024, more recent inflation readings suggest that core inflation is turning out to be stickier. While global core goods inflation eased significantly with the removal of supply chain bottlenecks, falling commodity prices, and weak goods demand during 2023, this decline has been fading recently amid a pickup in goods demand and firming input costs. Services inflation is stickier as a result of solid service sector activity and tight labor markets. These have given pause to expectations of rate cuts by major central banks.
Against this backdrop, major central banks have remained on hold over the course of 2023 and early 2024. However, both central banks and markets are eyeing the start of the policy rate cut cycle ahead. At the press conference following its early May meeting, Chair Powell ruled out the possibility of rate hikes, absent a deterioration in the inflation outlook. Provided inflation makes further progress toward the 2% target, the Fed is setting up rate cuts in the second half of 2024. Meanwhile, the European Central Bank, which has kept policy rates unchanged since September 2023, signaled in its April statement that it will go meeting-by-meeting, but would be willing to cut rates if inflation moves closer to its 2% target. By contrast, the Bank of Japan ended its ultra-loose monetary policy in March by exiting negative interest rates and Yield Curve Control.
Long-Term Global Economic Outlook: We expect real economic growth in developed economies to continue to moderate over the next decade, as it has for the last 30 years. This is due to the limited growth of the developed labor force, which is constrained by domestic demographics. An assumption of no significant offset from improved productivity growth is an additional constraint on growth. Inflation in Developed Markets is also anticipated to moderate over the next 10 years, relative to the elevated rates of inflation observed in 2021 and 2022. Nevertheless, inflation is expected to be somewhat higher than in the period following the Global Financial Crisis of 2008 and prior to the COVID-induced recession of 2020. We expect long-run real economic growth and inflation in Emerging Markets to advance at higher annualized rates than in Developed Markets. Younger populations and higher rates of return on capital in Emerging Markets are driving higher rates of nominal economic output compared to Developed Markets.
Source: PGIM Quantitative Solutions as of 3/31/2024. Forecasts may not be achieved and are not a guarantee or reliable indicator of future results.
Equities: Our 10-year annualized nominal forecast return for Global Equities is 7.0%, a decrease from our forecast of 7.1% for the first quarter of 2024. The small forecast decrease is primarily attributable to less favorable valuations following an 8.3% advance in Global Equities in the first quarter of 2024. Our long-term return forecast for US Equities is somewhat lower, at 6.3%. Looking at the rest of the world, Developed Market Equities outside the US are forecast to return 8.0% and Emerging Market Equities are forecast to return 9.1% over the next 10 years. Cheaper valuations, as measured by historical valuation ratios, are driving stronger expected returns for non-US Developed Market Equities versus US Equities. While faster expected economic growth is a positive for Emerging Market Equities versus non-US Developed Market Equities, this effect is partially offset by relatively less attractive income returns.
Fixed Income: Global sovereign interest rates moved broadly higher in the first quarter of 2024 as expectations for global central bank rate cuts were pushed further out into 2024 amid a resilient global economy and still stubbornly high inflation. Our long-run forecast for hedged Global Aggregate Bonds is 4.0%, a small increase from our forecast from the prior quarter, due to the aforementioned increase in underlying sovereign rates. Our long-run forecast for US Aggregate Bonds is 4.6%, a slightly higher expected return relative to our forecast for Global Aggregate Bonds, attributable to higher initial yields partially offset by a positive contribution from hedging foreign currency exposure. At the end of our 10-year forecast horizon, we expect the Fed’s policy rate to be approximately 3.4%, which is about 200 basis points lower than the midpoint of the policy rate target range at the end of Q1 2024. Outside the US, Developed Market central banks (aside from Japan) are forecast to gradually decrease policy rates as inflation pressures subside and growth remains sluggish. In US credit markets, our forecast for average spreads over the next 10 years is somewhat higher than the spreads prevailing at the end of the first quarter of 2024, informing expected returns of 4.8% and 4.9% for US Investment Grade (IG) and High Yield Bonds, respectively.
Real Assets: Real Assets are broadly defined to include asset classes that have physical properties or have returns that are highly correlated with inflation. We include Commodities, REITs, and TIPS as Real Assets in our CMAs. Our forecasts for these asset classes are expected to outperform our 10-year US inflation forecast of 2.7%.
Private Assets: Our forecasts for US Buyout Private Equity, US Venture Capital Private Equity, US Mezzanine Private Debt, and Global Private Infrastructure are linked to the forecast outcomes of public market assets with a premium consistent with historical empirical outcomes, acknowledging the underlying illiquidity and potential leverage employed in these asset classes relative to public market counterparts. Our forecasts for Core and Opportunistic US Private Real Estate are based on inputs from the NCREIF Property Indexes and linkages to forecast US economic growth and inflation.
Currency and Currency Hedging Returns: Over the next 10 years, we are forecasting generally negative returns for the US dollar relative to Developed Market peers, with outcomes ranging from an annualized loss of -0.4% for the Australian dollar to a gain of 1.0% for the Swiss franc. Forecast outcomes for Emerging Market currencies range from an expected loss of -2.4% for the South African rand to a gain of 0.7% for the Taiwan dollar. Long-term currency hedging returns against a market-weighted basket of Developed Market exposures are forecast to be net positive for US investors as short-term interest rates are anticipated to be higher over the long term in the US relative to the Eurozone and Japan.
60/40 Portfolio Return1: Based on our long-term forecasts, a balanced portfolio of 60% Global Equities unhedged and 40% Global Aggregate Bonds hedged is forecast to return 6.2% annually over the next 10 years, identical to our forecast at the end of the first quarter of 2024.
1 For illustrative purposes only. All model portfolios have significant inherent shortcomings and do not consider many real-world frictions. There is no current PGIM Quantitative Solutions client portfolio with this composition of assets. It does not constitute investment advice and should not be used as the basis for any investment decision.
