Capital market assumptions (CMAs) are crucial for guiding long-term investment strategies and help investors make informed decisions across various asset classes. These assumptions, built through several analytical frameworks, provide a structured approach to assess risk and return expectations across global investment markets.
The latest CMA Report by BNY Investment Institute which offers a comprehensive analysis of expected market trends and economic conditions over the next decade identifies five key themes for APAC investors to watch.
The first and most significant theme is the normalization of the stock-bond correlation – which turned positive since the pandemic. This is particularly relevant for APAC investors in lower-yielding economies – who could enjoy higher income returns, on their global bond holdings, but also encounter greater volatility in their portfolios as the positive stock-bond correlation abates only slowly.
The main reason we expect a slow normalization of the equity-fixed income correlation is on account of continuing supply-side stresses on inflation and rising concerns over debt sustainability which could lead to steeper and more volatile yield curves.
The next significant theme which is likely to play out predominantly across Asia is deglobalization. Emerging markets will likely face a shifting landscape with challenges such as China's long-term economic slowdown and increasing worldwide protectionism.
However, opportunities remain, particularly in advanced manufacturing and India's positive economic outlook. While the growth premium of emerging markets has declined, their resilience to economic shocks makes them attractive for diversified growth opportunities.
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A third area which is relevant for APAC investors is private credit - where the debt market is expanding rapidly, offering attractive yields for income investors.
However, there remains near-term challenges, such as a buildup of dry powder and falling interest rates, could compress private credit yields and increase default rates above historical norms. Despite these challenges, private credit remains a valuable component of diversified portfolios due to its potential for higher returns and lower correlation with traditional asset classes.
The report identifies a few other themes that will shape capital markets over the next decade.
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The second wave of artificial intelligence (AI) which, as is widely known by now, is poised to revolutionize various industries, driving productivity and profitability. Businesses integrating AI early are likely to see higher earnings growth, particularly in the US, which is expected to be the fastest adopter of AI technology. This technological advancement will have widespread impacts beyond semiconductor manufacturing and electric industries, boosting corporate revenues and maintaining healthy margins.
Climate risk & resilience: Addressing climate risks is critical for building market resilience. The report underscores the importance of investing in sustainable infrastructure and implementing scalable solutions to navigate physical and transition climate risks is of utmost importance. With 2024 on track to be the hottest year on record, the urgency of addressing climate change-related risks is more significant than ever.
The report also goes over expected returns, over the coming decade, for equities, where modest improvement in equity earnings growth are likely to be driven by AI adoption. US equity markets are expected to outperform due to higher earnings growth, while non-US developed and emerging markets will also see gains, albeit to a lesser extent.
In fixed income markets, current yield levels and the trajectory of monetary policy enhance the attractiveness of fixed income markets. The report forecasts that US Treasury bills and domestic bond allocations will provide higher returns for US investors. It also emphasizes the importance of hedging international bond allocations to maximize risk-adjusted returns.
Alternatives, such as hedge funds, private equity, and real assets, offer diversification benefits and higher risk-adjusted returns. The report highlights that these asset classes can provide valuable protection against market volatility and inflation. It also notes that private investments, particularly in venture capital and private debt, are well-positioned to benefit from technological advancements and structural shifts in the economy.
Finally, managing currency risk is essential for international investments. The report outlines the methodology for developing currency assumptions, emphasizing the importance of hedging to manage exchange rate volatility. It provides projections for the US dollar, British pound, Euro and the Japanese yen – to help investors understand the potential impact of currency movements on their portfolios.
Aninda Mitra is head of Asia macro strategy at BNY Investment Institute
