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Get ready for brutally weak market returns over the next decade

MARKETWATCH 9:39 AM ET 10/18/2017

If you're an investor in desperate need of double-digit returns, then Morgan Stanley has some disappointing news for you.

Since bottoming in early 2009, the S&P 500 on average has posted double-digit returns. The benchmark index, which largely represents the U.S. stock market, is trading at record levels and by almost every valuation metric is considered richly valued.

Such high valuations, however, are usually associated with low or sometimes negative long-term returns. Meanwhile, concerted efforts by global central banks following the financial crisis have pushed interest rates around the world to historic lows.

"A traditional 60%/40% equity/bond portfolio in U.S. dollars will see 4.2% per annum over the next decade, while the same in euros fares only slightly better at 4.7%, and British pounds at 4.9%," analysts at Morgan Stanley wrote.

See also:Why long-term U.S. stock returns look dismal (http://www.marketwatch.com/story/why-long-term-us-stock- returns-look-dismal-2017-03-28)

If you are a Japanese investor, however, a 60/40 portfolio in yen terms sees above-average expected returns, driven by elevated equity risk premiums, according to Morgan Stanley.

They blame a combination of high valuations or falling risk premiums and much lower interest rates for this state of affairs. The spectrum, or curve, of expected returns from investible assets such as stocks, real-estate investment trusts and bonds, which include Treasurys, investment grade and high-yield bonds, is much flatter now than in the past 30 years.

Returns over the past 30 years ranged from 5% for the least riskiest to nearly 10% for the riskiest assets. In contrast, the curve for the next 10 years ranges from 2% to about 4%, as seen from the chart below.

"Returns are increasingly hard to achieve without taking on a lot more risk," the analysts said.

Read:Here is why your savings rate is more important than your investments' returns (http://www.marketwatch.com/story/ here-is-why-your-savings-rate-is-more-important-than-your-investments-returns-2017-07-20)

Still Morgan Stanley analysts say their formal allocation to stocks remains neutral and the reason has to do with the current phase of the business cycle.

According to the analysts, during a late-cycle environment, such as now, "stocks over-earn relative to long-term return expectations as valuations overshoot. In contrast, credit tends to underperform long-term return expectations in this stage of the cycle as rising idiosyncratic risk eats into the carry."

Carry refers to the benefit of owning a particular asset, even as the value of the asset fluctuates. For example, dividends or coupon payments are often seen as carry for stocks and bonds.

"Stocks screen as attractive on most fronts--being the least rich asset, which benefit from long-run portfolio reallocation flows, and see the biggest boost from the cycle," they concluded, adding that European and Japanese stocks offer better expected returns than U.S. equities.

When it comes to corporate credit, they urged caution, especially staying away from high-yield bonds, which tend to suffer from outflows and reallocation during late-cycle environments.

However, government bonds continue to hold value as a traditional diversifier, even though they too are richly valued.

"We recommend staying constructive in stocks, maintaining an underweight in bonds, and remaining cautious on corporate credit," they said.

-Anora M. Gaudiano; 415-439-6400; [e-mail]


(END) Dow Jones Newswires
10-18-170939ET
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