Why investors should get set for ten lean years

It didn’t matter too much what you invested in over the past decade. Most assets delivered strong returns. The MSCI World index of global equities had a gross total return around 12% per year in sterling terms (gross total return means including reinvested dividends but not allowing for the cost of taxes that some countries deduct from dividends). The S&P UK Gilt Bond index of British government bonds managed around 5.5% per year, with bonds with longer maturities doing better because they started on higher yields. UK commercial property has returned around 9% per year, according to the MSCI UK Monthly Property index.

Obviously things have got steadily tougher for cash as interest rates dwindle, and emerging market stocks failed to beat less risky developed ones (6% per year for the MSCI Emerging Markets index in sterling terms). But if your portfolio was well diversified between assets and countries, you’d normally have done fairly well – your individual choices didn’t matter that much.

The bull must run out of breath

That very satisfactory situation is unlikely to be repeated in the 2020s. We’ve had a bull market running for more than a decade almost everywhere. Most assets are significantly more expensive than they were in 2010. While markets often rise far beyond what looks rational, it’s difficult to see how such a broad-based bull market can last until 2030.

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The chart above shows long-term estimates for various asset classes from the US investment managers GMO and Research Affiliates. The two firms use different models, but both assume that extreme valuations are likely to revert back towards historical averages. This may not happen as quickly as you’d expect: GMO’s team was consistently wrong in its forecasts for US equities in the 2010s because both valuations and margins have remained very high. It may well be too pessimistic again. But even Research Affiliates’ less pessimistic model does not produce returns in any asset class that are close to what we’ve seen over the last ten years.

Both expect a big difference between the best and worst asset classes, with emerging-market stocks coming top. That’s helpful for investors – at least there is one asset class that offers some opportunities. But there are few investors who would be comfortable having most of their assets in emerging markets. So the wider conclusion for anybody who wants to keep a prudently diversified portfolio is that we must expect a much leaner decade – and prepare to save more (or spend less) to make our long-term financial plans work in that environment.