Long View Q2: Equity concentration risk & long-term esti-mates for Value, Growth and Small Cap

Summary

In this report, we present the DWS long-term capital market assumptions for major asset classes as of the end of June 2024 while exploring the risks to these forecasts.

After some modest weakness in early April, global equities rebounded quite strongly, bringing year-to-date returns into double digits. For Q2, the MSCI All Country World (“ACWI”) Index returned 2.9%, led by continued strong returns from the S&P 500, which was up 4.3%. Developed International equity returns were more challenging in Q2, down -0.3%, while Emerging Markets were the strongest performing segment of global equities, up 5.3% for the quarter.

Global fixed income markets were sideways in Q2, with the Bloomberg Global Aggregate Bond Index and the Bloomberg US Treasury Index each returning about 0.1%. Bond markets were a tale of two periods, facing challenging returns in the first 3 weeks of April with stubborn inflation driving US Treasury yields higher (peaking at 4.70%). However, a softer GDP print in the latter part of April followed by weaker than expected labor data in May saw US Treasury yields reverse course lower. Equity returns seemingly behaved in tandem with bond yields, where higher yields posed challenges to equity prices while a shift back toward easier monetary policy expectations seemed to provide support for equity prices.

After two years of persistent inflation and an inverted U.S. Treasury yield curve, there are finally imminent signs of policy rate cuts from the Federal Reserve later this year. Tight global equity risk premia—especially so in the US—and tight corporate credit spreads paint a benign economic outlook and a reasonable expectation around increasingly accommodative Fed policy over the coming quarters, reflected in the gradual normalization in nominal Treasury yields. As elevated equity prices have been driven disproportionately by a small subset of technology-focused US companies referred to as the “Great 8,” questions around equity concentration risk have also become increasingly top of mind for investors.

Our 10-year forecasts continue to look increasingly favorable toward fixed-income that reflects higher starting yield levels but bear the risk of owning nominal return assets. In particular, the strategic return outlook for US high yield bonds is now comparable to that of US equities, reflecting higher real yields than we’ve had since the Global Financial Crisis (“GFC”) in contrast with multi-decade-low equity risk premia driven in part by optimistic valuations for megacap tech names.

Our models now forecast an annual local currency  return of 6.0% for the MSCI All Country World Index (“ACWI”) over the next decade, versus 6.1% three months prior as well as an increase for the Global Aggregate Bond Index from 3.5% to 3.7%. At an aggregate level, we estimate the forecasted rate of return on a diversified portfolio at 5.7%*, unchanged from the level at the end of Q2.

^{*Source: Bloomberg as of 30 June 2024. DWS Calculations for a strategic asset allocation that targets volatility of 10%.}