Capital Market Assumptions

Five-Year Outlook

2017 Edition
Long-term asset class return expectations and forecasts for the years ahead.
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What should investors expect in 2018?
Asset Class Forecasts And Return Expectations
Modest growth, benign inflation and slowly increasing interest rates provide a constructive backdrop to our asset class forecasts.
Outlook: Equity Markets Supported By Profits
We think developed market equities will benefit from an outlook of steady growth and low inflation, which underpins earnings and supports higher valuations.

Our return forecast of 6.4% for developed markets is supported by revenue growth of 4.1% and a dividend yield of 2.3%; our return forecast for emerging market equities is stronger at 8.4%.
6.4%
Developed Market Equities Total Return Forecast
8.4%
Emerging Market Equities Total Return Forecast
Outlook Rationale
Developed-market equities find themselves in a sweet spot of modest growth and low inflation, underpinning earnings and allowing valuations to remain elevated. Emerging market equities remain attractive; valuations are too low for the stable economic environment we expect.
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Building Blocks to Total Returns
Constructive fundamentals and stable valuations should result in mid-to-upper-single digit total return.
Equities Created with Sketch. Profit Translation Revenue Valuation Dividend Total Return Europe U.S. 4.3 4.1 2.7 0.9 0.5 1.2 1.9 3.0 2.0 –1.2 –0.8 Japan U.k. Emerging Markets 0 0 –3 –3 3 3 6 6 9 9 Returns (%) 5.9 7.2 6.0 4.2 3.8 –1.5 6.6 6.7 1.3 2.3 –2.0 8.4
Equities-m Created with Sketch. Profit Translation Revenue Valuation Dividend Total Return Europe U.S. 4.3 4.1 2.7 0.9 0.5 1.2 1.9 3.0 2.0 –1.2 –0.8 Japan U.k. Emerging Markets 0 0 –3 –3 3 3 6 6 9 9 Returns (%) 5.9 7.2 6.0 4.2 3.8 –1.5 6.6 6.7 1.3 2.3 –2.0 8.4
Source: Northern Trust Investment Strategy, Bloomberg, MSCI. Components may not exactly equal total return due to compounding. Returns shown reflect Northern Trust CMA forecasts.
Outlook: Fixed Income — No Bubble
Investment-grade bond forecasts are helped by the higher level of yields this year, and returns will be supported by the controlled shift higher in rates over the next five years.

We only expect the U.S. Federal Reserve to get the Fed funds rate to 2.0% at the end of our forecast period and we expect the Bank of Japan to be stuck at a 0.0% policy rate.

We think the slow upward move in U.S. short rates will lead to a 3.0% yield on the 10-year Treasury, as compared with a 0.5% yield on the 10-year Japanese government bond and 1.8% on the German Bund.
2.2%
Expected Annualized Return For Global Investment Grade
4.5%
Expected Annualized Return For Global High Yield
Outlook Rationale
Investment-grade forecasts are benefiting from a higher yield starting point and a controlled shift to higher interest rates. Cash returns are still likely to underperform inflation over the next five years. Normalized high yield credit spreads (from last year’s oil price weakness) mean lower returns.
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A Gradual Shift Higher
Higher interest rates will occur gradually and have been priced in across most regions.
Fixed-income Created with Sketch. 5-Year Forward Current 2017 NT CMA Yield (%) 3-Month United States 10-Year 0 –1 1 2 3 3-Month United Kingdom 10-Year 0 –1 1 2 3 3-Month Japan 10-Year 0 –1 1 2 3 3-Month Germany 10-Year 0 –1 1 2 3
Fixed-income-m Created with Sketch. 5-Year Forward Current 2017 NT CMA Yield (%) 3-Month United States 10-Year 0 –1 1 2 3 3 3-Month United Kingdom 10-Year 0 –1 1 2 3 3-Month Japan 10-Year 0 –1 1 2 3 3-Month Germany 10-Year 0 –1 1 2
Source: Northern Trust Investment Strategy, Bloomberg. As of June 30, 2017.
Outlook: Real Assets Dealing With Transitions
We don’t believe natural resource demand is dead, and underinvestment will eventually pressure supply. Our forecast for natural resources is 7.4%.

Developed economy infrastructure needs provide longer-term opportunities as cash-strapped governments look to the private sector for help, keeping our global listed infrastructure total return forecast at 5.8%.
7.4%
Natural Resources Total Return Forecast
6.1%
Real Estate Total Return Forecast
5.8%
Global Listed Infrastructure Total Return Forecast
Outlook Rationale
Factors underpinning real assets have softly faded over the past year. Natural resources have bounced back from an oversold position; global listed real estate and global listed infrastructure have slightly greater competition from slowly rising interest rates. All retain key roles in a multi-asset class portfolio.
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ESTRANGED RELATIONSHIP
The tight correlation between commodities and emerging market equities has been fading.
Commodities
Emerging Markets Equities
Source: Northern Trust Investment Strategy, Bloomberg.
Emerging Markets = MSCI Emerging Markets Index
Outlook: Alternative Assets Add Value
Our 4.4% hedge fund return forecast represents the combination of expected alpha (0.6%) and expected returns from risk exposures (3.8%). We still expect private equity to generate a 2.0% premium to public equities.
4.4%
Hedge Fund Return Forecast
8.4%
Private Equity Return Forecast
Outlook Rationale
We view hedge funds, in aggregate, as just one large multi-asset class portfolio with notable exposure to market risk. They add value by generating alpha, not returns. Broad industry hedge fund expected alpha ticked up slightly (0.5% to 0.6%). But alpha varies significantly by strategy and manager skill level, making the selection process paramount.

For private equity, our 2.0% illiquidity premium forecast is below the 2.5% long-term average as private equity managers navigate crowded markets.
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TRUE ALPHA GENERATION HAS SLIPPED OVER TIME
Hedge funds’ reliance on risk exposures to generate total returns has been increasing.
Hedge Fund vs. Balanced Portfolio — 10-Year Rolling Returns
Hedge Fund Total Return
Balanced Portfolio Total Return
Source: Northern Trust Investment Strategy Bloomberg, Hedge Fund Research. Hedge fund returns represented by the HFRI Fund Weighted Index. Past performance is not indicative of future results. It is not possible to invest in an index.
Balanced Portfolio = 50% Bloomberg BarCap Global Aggregate Index/50% MSCI ACWI
More Asset Class Insights
Get our latest asset class views as shared on our Point of View blog, AssetTV and other media outlets.
4 Key Forecasts for Stocks and Bonds
Growth Opportunities Outside the US
Fixed Income 5-Year Outlook: Low Rates, Low Inflation
Smarter in 60 Seconds: Tackling Low Rates and Modest Growth
6 Key Themes
Here are the key themes we believe will shape the investment landscape in the next five years.
Entrenched Growth

The global economic expansion will continue at a modest but steady pace.

Some of the forces contributing to the entrenchment include high debt burdens, aging developed market populations and transitioning emerging economies.

Economic Growth by Expansion Era
Global economic growth after the global financial crisis has settled into a slow-but-steady channel.
theme-entrenched-growth Created with Sketch. Developed Global Emerging 1983– 1990 1994– 2000 2002– 2007 2010– 2016 0 1.6 3.2 4.8 6.4 8.0 Average annual growth (%)
theme-entrenched-growth-m Created with Sketch. Developed Global Emerging 1983– 1990 1994– 2000 2002– 2007 2010– 2016 0 1.6 3.2 4.8 6.4 8.0 Average annual growth (%)
Source: Northern Trust Investment Strategy, IMF
Stuckflation

The bigger risk to the global economy continues to be too little — not too much — inflation.

We expect that inflation will remain subdued as automation-enabled supply easily meets demographic-hobbled demand. Pockets of sustained inflationary pressures (e.g., health care and education) will be addressed through innovation.

Energy Units* Per $1 Trillion of GDP
Energy efficiency continues to improve.
theme-stuckflation Created with Sketch. Global 1980 1990 2000 2010 2016 0 30 60 90 120 150 Energy Units/$1 Trillion of GDP 0.6% 1.8% 0.9% 1.8%
theme-stuckflation-m Created with Sketch. Global 1980 1990 2000 2010 20`6 0 30 60 90 120 150 Energy Units/$1 Trillion of GDP 0.6% 1.8% 0.9% 1.8%
Efficiency gains over previous decade (annualized)
Source: Northern Trust Investment Strategy, BP Statistical Review, IMF. *One million tons of oil equivalent
Waiting for Monetary Godot

Patience, gradualism and communication are monetary watchwords going forward.

We expect central banks to focus on successfully unwinding their huge balance sheets, likely ending up at a higher value than historical levels.

Total Assets by Central Bank
The major central banks have amassed nearly $14 trillion of assets, holding sizable portions of the market.
theme-godot Created with Sketch. 2007 2010 2013 2016 0 800 1,600 2,400 3,200 4,800 4,000 Total assets ($, billions) European Central Bank Federal Reserve Bank of Japan
theme-godot-m Created with Sketch. 2007 2010 2013 2016 0 800 1,600 2,400 3,200 4,800 4,000 Total assets ($, billions) European Central Bank Federal Reserve Bank of Japan
Source: Northern Trust Investment Strategy, Bloomberg, central bank reports
Populist Catharsis

Out of a seemingly chaotic environment, areas for economic and political improvement are uncovered.

While the markets prefer policy stability, when change is required, they will reward policies that move toward new solutions.

Economic vs. Political Freedoms
Economic freedom is generally correlated with political freedom – but some exceptions exist.
theme-catharsis Created with Sketch. 15 20 25 10 5 0 25 20 15 10 0 5 Economic Freedom (1 = Highest) Norway Netherlands Germany United States United Kingdom Australia Switzerland Canada Hong Kong Singapore Taiwan Spain Japan Italy France Korea Indonesia Mexico India Brazil China Russia Turkey Saudi Arabia Sweden Democratic Freedom (1 = Highest)
theme-catharsis-m Created with Sketch. 15 20 25 10 5 0 25 20 15 10 0 5 Economic Freedom (1 = Highest) Norway Netherlands Germany United States United Kingdom Australia Switzerland Canada Hong Kong Singapore Taiwan Spain Japan Italy France Korea Indonesia Mexico India Brazil China Russia Turkey Saudi Arabia Sweden Democratic Freedom (1 = Highest)
Source: Northern Trust Investment Strategy, Economist Intelligence Unit, Heritage Foundation
Regulation in the Limelight

Amid political gridlock, regulations are driving the global business and investing environment.

Around the globe, we expect to see both government and nongovernment agents shaping “smart” regulations for the new economy.

Number of Executive Actions in First 100 Days as President
President Trump signed more executive actions in his first 100 days as president since Harry Truman.
theme-regulation-limelight Created with Sketch. Harry S. Truman Jimmy Carter Lyndon B. Johnson Bill Clinton Dwight D. Eisenhower Ronald Reagan Richard Nixon George W. Bush John F. Kennedy George H.W. Bush Gerald Ford Barack Obama Donald Trump 0 8 16 24 32 48 56 40 32 18 12 13 11 18 16 22 15 17 23 20 58
theme-regulation-limelight-m Created with Sketch. Harry S. Truman Jimmy Carter Lyndon B. Johnson Bill Clinton Dwight D. Eisenhower Ronald Reagan Richard Nixon George W. Bush John F. Kennedy George H.W. Bush Gerald Ford Barack Obama Donald Trump 0 8 16 24 32 48 56 40 32 18 12 13 11 18 16 22 15 17 23 20 58
Source: Northern Trust Investment Strategy, Office of the Federal Register
Valuation Superstructure

Low interest rates and a rising proportion of higher quality companies support greater-than-average valuations.

Significant changes to financial markets’ structure, players and investment vehicles lead us to believe today’s valuations will endure.

MSCI World Composition: 10 Years Ago vs. Today
Larger allocations to higher-valuation sectors suggest prices are not as stretched as they seem.
theme-valuation-A Created with Sketch. High Valuation Sectors 38% Cons. Disc. Materials Financials Info. Tech. Energy Cons. Staples Utilities Health Care Telecom Industrials
theme-valuation-A-m Created with Sketch. High Valuation Sectors 38% Cons. Disc. Materials Financials Info. Tech. Energy Cons. Staples Utilities Health Care Telecom Industrials
Source: Northern Trust Investment Strategy, Bloomberg, MSCI. Note: real estate included in financials
More on Our Themes
We analyze the trends and themes driving economic and market activity in the next five years.
Bob Browne 5-Year Outlook: Entrenched Growth, Stuckflation
Stuckflation, Entrenched Growth and 4 More Predictions for Your Portfolio
5-Year Market Outlook: Can Slow & Steady Win the Race?
MarketScape: Prospects for an Inverted Yield Curve
6 Key Themes for the Next 5 Years
CMA Five-Year Outlook: 2017

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Download Our 5-Year Outlook
Find out what investors should expect in the years ahead.
Download Executive Summary
Every year, Northern Trust’s Capital Market Assumptions Working Group develops forward-looking, historically aware forecasts for global economic activity and financial market returns — which drive our five-year asset class return expectations and inform our asset allocation decisions.

All of this comes together in the form of our long-term strategic asset class allocation suggestions, which are used by institutional and individual investors worldwide.
Contributors
David Blake
Asset Management
Director, International Fixed Income
Bob Browne, CFA
Northern Trust
Chief Investment Officer
Brad Camden, CFA
Asset Management
Director, Fixed Income Strategy
Michael DeJuan, CIM®, CAIA
Asset Management
Director, Portfolio Strategy
Peter Flood
Asset Management
Director, ETF Investment Strategy
Jim McDonald
Northern Trust
Chief Investment Strategist
Peter Mladina
Wealth Management
Director, Portfolio Research
Katie Nixon
Wealth Management
Chief Investment Officer
Matt Peron
Asset Management
Managing Director, Global Equities
Dan Personette, CFA
Asset Management
Director, Interest Rate Strategy
Brad Peterson
Wealth Management
Senior Portfolio Manager
Dan Phillips, CFA
Northern Trust
Director, Asset Allocation Strategy
Colin Robertson
Asset Management
Managing Director, Fixed Income
Carl Tannenbaum
Northern Trust
Chief Economist
Northern Trust Asset Management
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With $1.2 trillion in total assets under management,1 and a long-standing history of solving complex investment challenges, we believe our strength and stability drive opportunities for our clients.
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1Represents total assets managed by the subsidiaries of Northern Trust Corporation as of December 31, 2017. 2Unless otherwise noted, rankings are based on total worldwide assets under management of $942.4 billion as of December 31, 2016 by Pensions & Investments magazine’s 2017 Special Report on the Largest Money Managers. 3Asia Asset Management, 2015. 4Institutional Investor, 2013 and 2014. 5U.S. Institutional, tax-exempt assets managed internally. 6Pensions & Investments as of March 31, 2017. 7U.S. Institutional, tax-exempt assets managed internally.
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