Investors used to a more than 10-year stock market bull run should expect lower returns during the next decade amid slowing global growth, economists and fund managers are warning.
Canadian investors saw solid 5-per-cent to 7-per-cent annual portfolio gains between 2010 and 2018, outperforming the previous decade, according to a report by TD Economics. Looking toward the next decade, however, investors could see more modest gains as GDP growth in developed countries slows and central banks maintain low interest rates.
The largest slump could come from U.S. markets after a decade of high-flying tech stocks boosted the S&P 500. But as corporate growth slows, U.S. equities could see returns in the 4-per-cent to 7-per-cent range on average over the next decade – a significant decline from the stellar 15-per-cent average annual return in Canadian dollars over the past decade.
“We’re going into a time period when growth isn’t going to be as strong as it was in the past,” TD senior economist James Orlando said.
While Canadian equities lacked blockbuster stocks, companies experienced sustainable levels of growth and won’t see the same relative drop expected of U.S. stocks, according to Mr. Orlando. The Canadian market’s performance could maintain its status-quo relative to the past 10 years after a decade marked by low oil prices after the 2015 oil collapse and lower earnings growth, which stifled gains. Since 2010, the S&P/TSX Composite Index experienced more modest gains, returning 5.3 per cent annually, down from 5.6 per cent between 2000 and 2009, according to the report.
In response to more paltry performance in Canadian equities, investors increased their international exposure – and the strategy seemed to work as the Canadian dollar fell. About 3 per cent of annual S&P 500 and MSCI EAFE performance came from the depreciation of the Canadian dollar, according to TD Economics.
Slower GDP growth will weigh heavily on stocks, TD Economics said. A significant portion of GDP in developed economies goes to corporations, with that share currently sitting at around 10 per cent to 11 per cent in the United States and Canada. Moving forward, that is expected to dip. Developed economies are projected to grow around 4 per cent nominally over the next 10 years, and domestic profit growth would fall to around 4 per cent, according to the report. This means that companies will need to expand globally to grow profits, Mr. Orlando said.
“They’ll have to go elsewhere and increase their exposure in an effective way to higher growing markets,” he said. “And we’ve seen this. This is why tech firms have done so well in the U.S. – services are able to be sold very easily internationally. But are they going to be able to continue expanding their net globally?”
Even with the high valuations of U.S. stocks, there could still be more room to climb, according to Kurt Reiman, BlackRock’s chief investment strategist for Canada. The firm’s outlook on the next decade also anticipates lower returns, but with slightly less bearish estimates than the TD Economics figures. BlackRock expects U.S. large cap equities to return an average of 6.1 per cent annually over the next decade, emerging market large cap equities to return 6.8 per cent, and European large cap stocks to return 8.1 per cent.
“This isn’t the first year that people are calling for subpar returns in equities and fixed income and in the recent past we’ve actually seen otherwise," Mr. Reiman said. "But the downside is also true. When I think about the next 10 years, we are deep in the economic cycle and valuations are fair to slightly expensive and we’re dealing with [a] geopolitical feature which will be a more defining feature in terms of impact on the real economy.”
After an extended bull market in the U.S., returns will stop justifying the valuations and investors will need to diversify their portfolios by looking to other markets, said Craig Basinger, chief investment officer at Richardson GMP. While his asset allocation currently does not have any exposure to emerging markets, he said that in the next decade he expects to be overweight on emerging markets and international developing markets.
“They’ve been starved for capital for such an extended period of time and that means that returns will gradually start to improve and the U.S. has been flooded with capital, meaning that things are being funded that probably shouldn’t be,” Mr. Basinger said.