By: Garrett D’Alessandro, CFA, CAIA, AIF®
Chief Executive Officer & Chief Investment Officer, City National Rochdale
Since the end of the great recession and financial crisis, equity investors have experienced a healthy average annual rate of return. If you were invested in blue chip equities or dividend equities, the average annual total return over the past six years was between 15% and 17%.
Now that the economic recovery is in its seventh year, what should investors expect for economic growth and equity returns if the circumstances ahead unfold according to our base case? Our base case is not one that has a 90% probability of occurring; instead, we believe our base case has about a 60% likely outcome, with a slow case and a better case each with about a 20% probability. Taking into consideration the two most influential factors when estimating forward equity returns, the phase of the economic recovery and the potential for equity earnings growth, our base case twelve month forecast calls for earnings for blue chip companies to be between 3% and 5%, and funds from operations for dividend companies to be between 3% and 6%. At 86 months, some believe time has run out for investors to continue to earn a positive return from equities. For our base case, we believe time is not the factor to analyze, but rather a comprehensive set of micro- and macroeconomic and company factors that provide a better look forward. We see the economy moving ahead modestly, about 2% to 2.25%, and earnings remaining positive for the remainder of 2016.
On the merit of these factors, equity investors have the potential opportunity to earn a total return of 4% to 6% for the year on blue chip equities, and perhaps 5% to 7% for high-dividend-paying equities. When one combines this with our base case twelve month forecast, expected returns for investment-grade fixed income of between 2% and 3%, it generates a potential for a balanced portfolio of approximately 4%.
For those interested in a little more detail, we see the current valuation of equities as around fair value. As for bonds, our view is that investment-grade bonds, taxable or municipal, are fully valued. We believe high-yield bonds are also at fair value. We also believe there are no bargains available in any of the liquid primary investment markets across asset classes. There are some we slightly favor, but none that we believe represent a significant investment opportunity.
In summary, there are times during an economic expansion and positive equity market when we like to make stronger investment commitments in which to capture attractive return opportunities, as we have successfully done during this expansion and long equity bull market. Having navigated many cycles over the course of the last three decades in business gives us the wisdom and experience to know how to manage our return expectations so that our client portfolios are properly positioned. That is in contrast to other managers who will continue to press for higher returns and, as they do so, increase the risks. Our view is that now is not a time to take on more risk, but to set expectations for a moderate return. After a long positive period for equities, we are in the later phases of this bull market. For now, our base case indicates a positive year for equities and bonds. Given low inflation, these nominal returns should be viewed a little more favorably than if we expected 4% from a balanced portfolio with inflation at 3%.
All returns cited are in USD. Index returns include the reinvestment of dividends.
The information presented does not involve the rendering of personalized investment, financial, legal, or tax advice.
Certain statements contained herein may constitute projections, forecasts, and other forward-looking statements. Certain information has been provided by third-party sources and, although believed to be reliable, it has not been independently verified and its accuracy or completeness cannot be guaranteed.
Any opinions, projections, forecasts, and forward-looking statements presented herein are valid as on the date of this document and are subject to change.
All investing is subject to risk, including the possible loss of the money you invest. When interest rates rise, bond prices fall.
Past performance is no guarantee of future performance.
This material is available to advisory and sub-advised clients of City National Rochdale, LLC, a Registered Investment Advisor and a wholly owned subsidiary of City National Bank.