Our 2021 Capital Market Assumptions

Multi-Asset | June 2021

Notes from the Multi-Asset Strategies Desk

By Radu Gabudean and Rich Weiss

Lower near-term return expectations

Coming out of a pandemic and on the heels of unprecedented monetary and fiscal stimulus, we believe conditions argue for modest short-term returns relative to the past and our own long-term forecast. That’s because zero cash yields and record high stock prices weigh on return projections over the next three to five years. As a result, the expected annual return to a portfolio of 60% global stocks/40% global bonds stands at 3.8%, compared with 6.0% for the updated long-term (20-year) forecast.

New horizons, same process

In Figures 1 and 2, we present our updated return and volatility forecasts for 29 asset classes across both near- (three- to five-year) and long-term (20-year) horizons using current data and market values. In contrast, our prior work used a single 10-year horizon meant to capture a complete market cycle. In this update, we’ve taken a more nuanced approach. The “short-term” measure is intended to better reflect near-term economic and market conditions, providing three- to five-year projections (Figure 1). The long-term, 20-year return forecast is meant to capture steady-state, long-run risk premia and relationships across asset classes (Figure 2).

We outlined our multi-model approach to forecasting in our 2019 paper titled, “Long-Term Capital Market Assumptions .”1 While our forecast horizons have now changed, the methodology has not. Complete 2021 assumptions for return, risk and correlation across each asset class are available in the Appendix .

Figure 1 | Three- to Five-Year Forecast Is Uniformly Below Current Long-Term and Prior Projections



Data as of February 2021. Source: American Century Investments. Returns are simulated based on capital market assumptions from our Multi-Asset Strategies’ short- and long-term forecasts. Forecasts are not reliable indicators of future performance.


Figure 2 | Long-Term Return Assumptions “Normalize” Despite Unique Starting Point



Data as of February 2021. Source: American Century Investments. Returns are simulated based on capital market assumptions from our Multi-Asset Strategies’ short- and long-term forecasts. Forecasts are not reliable indicators of future performance.


Emerging market equities show well over both horizons; non-U.S. developed market equities preferred for the near term

Figure 3 shows non-U.S. developed and emerging markets equities (EMEs) offer the highest anticipated returns in the short-term forecast. This reflects the starting point of U.S. equities at record-high prices and comparatively higher valuations, with non-U.S. developed market equities looking like better relative values. EMEs enjoy among the highest absolute return projections by virtue of offering attractive relative earnings growth and valuations compared with developed markets. However, EMEs also bring the highest expected volatility; as a result, their Sharpe ratios (a measure of risk-adjusted performance) are only middle of the pack over both forecast horizons. The highest Sharpe ratios among the equity cohort in our three- to five-year forecast are reserved for developed non-U.S. equities.

One look at our risk premia approach to the U.S. equities forecast explains the relatively less favorable return projections for these asset classes in the short run. In this model, the return forecast is a function of the risk-free rate (cash yields) plus a bond premium and an equity premium. Our bond and equity risk premia are only slightly changed in both the short- and long-term forecasts relative to our 2020 estimate. That means the lower expected near-term U.S. equity returns are almost entirely the product of the low risk-free rate. In contrast, the long-term (20-year) forecast assumes a return to normalized, long-term historical cash yields. Essentially all forecasts in Figure 3 are colored by this single expectation of very low cash returns in the near term versus higher long-term cash rates. As a result, the short-term return forecasts are uniformly below both the prior forecast and latest long-term forecasts.

Separately, our “building blocks of valuation” approach to forecasting equity returns captures such inputs as shareholder yield, earnings growth and valuation changes. This provides context for understanding why U.S. growth equities across the capitalization spectrum earn the lowest expected return among all equity segments in our three- to five-year forecast. Here, we focus on the valuation component, as a pandemic-long rally in growth stocks leaves these shares expensive relative to history and earnings.

Another fundamental consideration with bearing on growth stock valuations specifically is the Federal Reserve’s (Fed’s) seeming inclination to allow inflation to overshoot its long-run target of 2.0%. Inflation concerns are driving bond yields higher, which has repercussions for long-duration assets such as U.S. growth stocks.

Value-oriented U.S. equities favored under long-term forecast

In contrast to our near-term forecast, U.S. equities have among the highest projected returns in our long-term analysis. This reflects the reversion to long-term relationships, which show the U.S. outperforming non-U.S. developed equities by a meaningful margin for more than a century. We don’t try to explain this enduring structural advantage, but we see no reason to assume it will end anytime soon. As a result, U.S. equities enjoy a premium over their developed market peers.

Within U.S. equities, we favor value over growth as a result of relative valuations. The relationship between growth and value stocks reached unprecedented levels in late 2020 and has been reverting to more normal levels ever since for the fundamental reasons mentioned above. We see this reversion as an ongoing process, resulting in our preference for value over growth for both the short- and long-term forecasts.

We believe corporate bonds offer attractive absolute and risk-adjusted returns

For both horizons, our fixed-income forecasts favor U.S. high-yield and high-quality corporate bonds, with the latter providing a better Sharpe ratio. Only mortgage-backed securities (MBS) offer a Sharpe ratio in excess of investment-grade corporate bonds across every asset class we analyzed for the near-term period. In fundamental terms, improving economic growth and supportive Fed policy mean current corporate yield spreads are reasonably attractive and could tighten further. Or think of it in terms of our model, which includes a Treasury return estimate and yield premium above Treasuries for credit-sensitive bonds.

Figure 3 | Three- to Five-Year Forecast Returns Uniformly Below Long-Term Current and Prior Projections



Data as of February 2021. Source: American Century Investments. Returns are simulated based on capital market assumptions from our Multi-Asset Strategies’ short- and long-term forecasts. Forecasts are not reliable indicators of future performance.


Here, we dive deeper into cash yields because they set the risk-free rate in our risk-premium forecast models. Indeed, differences in cash returns are the key driver of the disparity in our short- and long-term forecasts. Of course, cash yields in the U.S. have been essentially zero since March 2020, reflecting Fed policy in the wake of the pandemic.

These conditions are not exclusive to the U.S.—short-term interest rates are zero (or less!) in virtually every developed market country. But while cash yields are effectively zero today, we expect these rates to inch back up over the next several years. For example, if the post-COVID economic recovery takes off, or if present market concerns about inflation come to pass, then that would likely argue for central banks lifting their interest rate targets down the road.

The cash assumption for our three- to five-year forecast is an average of 0.75% (Figure 4). This is not meant to imply these returns are expected today or even six months or one year in the future. Rather, we believe this is a reasonable assumption for average cash returns over the forecasted three- to five-year period.

Figure 4 | Wide Variation in Both Realized and Expected Cash Returns Over Time



Returns are simulated based on capital market assumptions from American Century Investments Multi-Asset Strategies' 2021 long-term, 2021 short-term and 2020 long-term forecasts. Forecasts are not a reliable indicator of future performance. Peer Max, Peer Median and Peer Min aggregated from peer publicly available websites. Long-term return assumptions based on 13 peers. Short-term volatility assumptions based on 5 peers. 2021 Long-Term and Short-Term Forecasts as of March 2021. 2020 Long-Term Forecast as of December 2019. Source: American Century Investments.


As a reality check, we compared our forecast with the Fed’s own projections from its March 2021 meeting. The Fed’s “dot plot” forecast of future interest rates suggests no deviation from its zero-rate policy until 2023. The Fed funds rate forecast ranges from essentially zero to 1.4% in 2023. By comparison, its longer-term rate projection is 2% to 3%. Our own long-term (20-year) forecast for cash is 2%, which reflects our intuition, a significant body of academic research and historical return data which all indicate cash should yield inflation plus a small premium. So, it should come as no surprise that this 2% average long-term cash return forecast is slightly ahead of our inflation expectation for the same period. Add it all up, and the low level of cash returns explains why our short-term (three- to five-year) returns are lower in every case than they were in our prior (10-year) capital market assumptions and lower than they are in our long-term (20-year) assumptions.

Note that our view stands in clear contrast with the long-term peer median forecast, which calls for 1.3% cash returns (Figure 4) alongside 2% inflation (Figure 5). It is, of course, possible to find historical examples of extended periods of low or even negative cash rates—look at the Japanese and European Central Bank policies for the better part of two decades and five years, respectively. But their economies in these periods also have been characterized by low or outright negative inflation.

Or consider the U.S. case, when the Fed maintained interest rates near zero for the better part of a decade in the wake of the Great Financial Crisis (GFC). You can see the effect of this policy in Figure 4, noticeably depressing the average cash return for the 10- and 20-year periods. As a result, the inflation average exceeds the cash rate for those historical periods (Figure 5). Now compare those historical averages with the long-term peer median forecasts—effectively, our peers are forecasting the next decade will be very much like the last few. We don’t doubt this is possible, but we don’t believe it is probable. Just contrast the dramatic fiscal response in the wake of the pandemic with the anemic one following the GFC. Or consider the different nature of the two crises—one was a systemic, enduring financial crisis, while the other was an abrupt demand shock, with very different prospects and timeline for recovery.

Inflation Also Suggests Lower Near-Term Returns Relative to Long-Term Projections and Prior Forecast

We conclude with a discussion of inflation, whose importance to our methodology we explained in our detailed 2019 paper . For our purposes here, suffice it to say we require an explicit inflation forecast to derive the nominal (after-inflation) return for each asset class. For example, our equity valuation approach uses inflation as an explicit input, as does one of our fixed income return projections, in addition to term and real rate premiums. Figure 5 indicates our near- and long-term forecast relative to peers and history.

Figure 5 | Modest Inflation Expectations Color Return Forecasts



Returns are simulated based on capital market assumptions from American Century Investments Multi-Asset Strategies' 2021 long-term, 2021 short-term and 2020 long-term forecasts. Forecasts are not a reliable indicator of future performance. Peer Max, Peer Median and Peer Min aggregated from peer publicly available websites. Long-term return assumptions based on 13 peers. Short-term volatility assumptions based on 5 peers. 2021 Long-Term and Short-Term Forecasts as of March 2021. 2020 Long-Term Forecast as of December 2019. Source: American Century Investments.


Our forecast is more conservative than that of our peers and the market at present. In short, the market’s view is that resurgent economic growth, low interest rates and massive fiscal stimulus will cause an inflation spike. We recognize these concerns, but don’t see evidence that the labor market is healthy enough to drive sustained inflation for the period of our near-term forecast. Consider that while the unemployment rate stood at 6.1% in April, it was 3.5% as recently as February 2020, while the labor force participation rate is 1.6 percentage points below pre-pandemic levels, meaning millions fewer Americans are actively looking for work today.2

It’s a similar story in manufacturing—industrial production remained 2.7% below its February 2020 pre-pandemic high, while the capacity utilization rate has rebounded from crisis lows but is still nearly 5% below its long-term average.3 So, while we recognize that inflation has spiked in the near term, we believe these factors all speak to excess capacity in the economy that we believe allows for a meaningful rebound without causing enduring inflation.

Finally, we think the market may be underestimating the risk to a sustained recovery from virus mutations or a lack of vaccine uptake that slows or prevents herd immunity. In the same week the Centers for Disease Control and Prevention (CDC) data showed almost 22% of the U.S. population was successfully vaccinated, the World Health Organization announced 4.4 million new cases of COVID globally and said we are at a “critical” juncture in the progress of the disease. We are not debating epidemiological outcomes; rather, simply noting that meaningful risks remain so the market may be premature in assuming a rapid, uninterrupted economic recovery that would drive inflation higher.

Longer term, we see several factors limiting inflation, leading to our forecast of 1.75% inflation over the 20-year horizon. These factors include technology’s effect on pricing throughout the economy as a result of the so-called “Amazon effect,” ongoing automation and accelerating digital disruption across a broad swath of industries. Similarly, demographic trends (e.g., a graying population and Baby Boomers entering retirement) and the need for workers to catch up on retirement savings suggest reduced spending and consumption relative to the past. As a result, we think inflation can slightly undershoot the Fed’s stated 2% target over time, which also explains why our forecast is below both available short- and long-term peer forecasts.


Our 2021 Capital Market Assumptions

1Radu Gabudean, Ph.D., and Rich Weiss, “Long-Term Capital Market Assumptions,” American Century Investments, September 2019, https://www.americancentury.com/content/dam/ac/pdfs/ipro/viewpoint/iuo/capital-markets-assumptions.pdf .

2“The Employment Situation—April 2021,” U.S. Bureau of Labor Statistics News Release, May 7, 2021.

3“Industrial Production and Capacity Utilization – G.17,” U.S. Federal Reserve, May 14, 2021.

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