Past three decades, investors have enjoyed receiving a decent return on their money in the stock and bond markets. But if a recent McKinsey & Co. report is correct, then leaner times may be ahead for both equity and fixed income investors. Diminishing Returns: Why Investors May Need to Lower Their Expectations, states that the average annual returns of the stock and bond markets may be dropping by anywhere from 1.5% to 4% per year. That projection is contingent upon economic growth recovering to the trend rate that it has followed for the past 50 years.
A Bleaker Outlook
The report begins by examining the past performance of equities in the U.S. For the past hundred years ending in 2014, U.S. equities have returned an average of 6.5%. The past 30 years ending on the same date, they have posted average annual returns of almost 8%. Bonds have posted an average annual return of 1.7%, but they have grown by an average of 5% over the past 30 years. And European equities have grown by almost 5% on average for the past hundred years and by 7.9% over the past 30 years. European bonds have grown by an average of 1.6% over the past hundred years and almost 6% for the past 30 years.
McKinsey refers to the past 30 years as a “golden era” of investing because of several key factors that helped to drive both the equity and fixed-income markets. A low rate of inflation, high international GDP growth and rising corporate profits all combined to allow the markets to exceed their average returns over the 100 year period. But the report indicates that some of these factors no longer exist. Declining interest rates and a slowdown in the GDP indicate that this period of growth may be over.
And global GDP has been fueled by simultaneous increases in both productivity and employment. This trend is also coming to an end because of the aging of the current workforce. The inability of subsequent generations to duplicate this growth will lead to a reduction in global GDP. At least a whopping 40% over the next 40 years. Other factors such as the increasing ability of smaller and emerging markets companies to compete with larger firms via online platforms will lower corporate profits.
However, the McKinsey report does not include three critical areas of the economy. Real estate/alternative investments are not factored in their findings, these areas all have the potential to increase projected returns. McKinsey also conceded that technological improvements that increase corporate productivity could also change their forecast for the better. Portfolio managers who are looking to improve their clients’ returns may want to increase their allocations in alternative investments.
Author: Mark P. Cussen