Home : Northern Trust Capital Market Assumptions 5 Year Outlook: 2021 Edition

ASSET CLASS FORECASTS AND RETURN EXPECTATIONS

Here’s a look forward on what to expect in the year ahead for equities, bonds, interest rates and real assets – and where to look for return potential.

Equities

Pent-up consumer demand driven by savings could drive a period of robust activity and take our earnings assumptions higher.

In 2021 we expect:

More moderate, single-digit returns across regions.

Robust economic activity with a consumer-spending surge.

Elevated valuations supported by increases in corporate earnings.

Fixed Income

Improving credit fundamentals and declining default rates continue to provide a tailwind to high yield in the year ahead.

In 2021 we expect:

Continued easy monetary policy, low interest rates and improving fundamentals.

High yield bonds to return 4.9% and investment grade bonds to return 1.9%.

Interest rates falling even lower.

INTEREST RATES

Quantitative easing and immediate lending support, should it be needed, will continue well into the year until the pandemic is behind us.

In 2021 we expect:

Interest rates to remain steady as central banks globally focus on economic recovery.

The Fed to continue its use of tools like quantitative easing.

The 10-year Treasury yield to move to 0.5% from below 1.0% currently.

Real Assets

As the global economy reemerges post-pandemic, there will be a lot of pent-up demand in railroads, pipelines and airports.

In 2021 we expect:

Global infrastructure returns could be a positive surprise.

Low valuations of global real estate and natural resources equities to cushion against further losses.

Global infrastructure equities to return 4.7%, global real estate to return 5.1% and natural resources to gain 3%.

A Truly Wild Ride

Markets can always be volatile, but the drawdown and recovery in 2020 was one for the record books.

Past perfomance is not indicative of future results.
Source: Northern Trust Asset Management, Bloomberg. Year-to-date data through 11/30/20. Five-year annualized data from 11/30/2015 to 11/30/2020. Index performance returns do not reflect any management fees transaction costs or expenses. It is not possible to invest directly in any index.

2021 Asset Class Outlook

Our asset class assumptions form the basis for our asset allocation framework, which combines long-term, strategic discipline with short-term, tactical flexibility.

ASSET CLASS

Developed Markets
Equal-weight

42%

U.S. valuations are high but a stabilizing U.S. policy outlook and positive COVID-19 vaccine news may open new opportunities. Europe has more attractive valuations but the pandemic has inflicted more damage on the economy, which may recover more slowly.

Emerging Markets
Equal-weight

Our overweight resides in global listed infrastructure, which has downside protection and cyclical upside as we recover from the pandemic. We are equal-weight global real estate with the offsetting forces of low interest rates (positive) and permanent impairment of some properties because of the pandemic (negative).

Global Real Estate/Infrastructure
2% overweight

Equity-based natural resources can help protect against unexpected inflation and geopolitical risks. Returns have been hurt by falling oil prices. But, despite the headwinds, attractive valuations with higher dividend yields keep us at equal-weight.

Natural Resources
Equal-weight

High Yield
3% Overweight

This is our highest conviction overweight position. High yield bonds historically have participated in equity gains and limited losses when equities fall, making the bonds desirable in the current volatile environment. As corporations sacrifice some growth for more stability, high yield sits in a sweet spot.

Investment Grade
2% Overweight

35%

33%

Investment grade bonds remain the best way to stabilize a portfolio during market stress and equity volatility. We are modestly overweight for additional stability. Also, we think central banks will remain on hold and long-term interest rates will remain low, supporting bond prices.

Inflation-Linked
5% underweight

The lack of inflationary pressures amid the pandemic drives our biggest underweight. We expect post-pandemic structural forces (efficiency from technology, lower consumer demand) to keep inflation below market and central bank expectations. When we do invest in inflation- linked bonds, we prefer those with short duration because of their higher inflation sensitivity.

Cash
2% Underweight

As the pandemic dragged down the global economy, central banks went firmly back to a zero interest rate policy. As such, cash returns will remain near zero over the tactical horizon. In this environment we believe cash should be held only for near-term liquidity needs.

Tactical Risk Position:

Moderate overweight to risk

Our overweight positions to high-yield bonds and global listed infrastructure equities result in a moderate overweight to risk. Heading into 2021, we believe that the potential for upside is slightly greater than the downside.

*TAA = Tactical Asset Allocation.
**SAA = Tactical Asset Allocation.

6 Key Themes

Our Capital Market Assumptions five-year market outlook provides insight into the forces shaping the investing landscape for the coming years. Here are the six key themes driving our tactical outlook and asset allocation for the next five years.

Retooling Global Growth

Companies will prioritize stability over profitability, tempering long-term global economic growth.

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Massive Monetary Toolkit

Driven by their ability to purchase securities through newly created money, central banks have massive toolkits.

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Stuckflation Tested

Inflation will be put to the test with several drivers seeking to push it higher, but not above central bank targets.

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One World, Two Systems

U.S. and China tensions will continue, leading to inefficiencies and the continued decline of globalization.

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Reimagining Capitalism

A focus on stakeholders over shareholders may mean less profit but also a more sustainable economic system.

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Stay Focused on Climate Risk

Mitigating climate risk will take on more urgency as the COVID-19 pandemic has shown how large, non-financial events can hurt returns.

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Companies will prioritize stability over profitability, tempering long-term global economic growth.

Companies will look to re-route supply chains, move production inside their home countries and build healthier balance sheets. After the stimulus-induced surge, we expect global growth will settle at low levels with annualized real growth of 2.6% over the next five years.

An Economic Bump Then a Slide

Economic growth will slow after an upfront bounceback from the pandemic's disruptions.

Source: Northern Trust Asset Management, Bloomberg. Data from 3/31/2015 to 3/31/2020.

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Driven by their ability to purchase securities through newly created money, central banks have massive toolkits.

The controversial Modern Monetary Theory (MMT) — which advocates for greater coordination between monetary and fiscal policy — is, in reality, already being applied. This de facto monetary-fiscal policy approach will prevent exogenous shock-driven recessions from becoming depressions.

To Infinity and Beyond?

The pandemic crisis has shown central banks have not run out of firepower.

Source: Northern Trust Asset Management, Bloomberg. Balance sheet size as of 12/31/2007, 12/31/2019 and 6/30/2020.

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Inflation will be put to the test with several drivers seeking to push it higher, but not above central bank targets.

Despite the forces testing the low inflation environment, we believe the continued impact of technology/automation combined with a slow demand outlook will keep inflation stuck over our five-year horizon.

Still struggling to hit the target.

A confluence of developments will push inflation higher, but not above central bank targets.

Source: Northern Trust Asset Management, Bloomberg. Data from 3/31/2015 to 3/31/2020. All regions use headline CPI as the inflation metric.

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U.S. and China tensions will continue, leading to inefficiencies and the continued decline of globalization.

As an “agree-to-disagree” dynamic takes hold, both countries will hold on to their own systems. Other countries and multi-national companies will be forced to pick a side or straddle the middle ground, leading to lost economic opportunity and/or economic inefficiencies.

A high level comparison of the world's two superpowers.

China has a big population advantage over the U.S. but lags in economic and financial market metrics.

Source: Northern Trust Asset Management, IMF, U.S. Census Bureau, Bank for International Settlements

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A focus on stakeholders over shareholders may mean less profit but also a more sustainable economic system.

For everyone to believe in (some form of) capitalism, rules alleviating the “winner-take-all” dynamic must evolve. Business leaders, the ultra-wealthy and politicians representing those left behind will find a way to forge a new capitalism that works better for all.

The rich are still getting richer.

Inequality has been on the rise for decades. The pandemic may accelerate that trend.

Source: Northern Trust Asset Management. Right panel -- 2018 U.S. Census Bureau.

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Mitigating climate risk will take on more urgency as the COVID-19 pandemic has shown how large, non-financial events can hurt returns.

The pandemic took the focus off climate-related issues, but the risks have not gone away. Post-pandemic economic rebuilding will force leaders to re-engage with climate risk — a headwind for some industries but a tailwind for others.

Developed Markets Taketh Away, Emerging Markets Giveth.

Developed economies are reducing carbon emissions slowly, but emerging market emissions -- notably China -- are still rising.

Source: Northern Trust Asset Management, PBL Netherlands Environmental Assessment Agency -- Trends in Global CO2 and Total Greenhouse Gas Emissions 2019.

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Northern Trust Asset Management

Northern Trust Asset Management is a global investment manager that helps investors navigate changing market environments, so they can confidently realize their long-term objectives.

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That’s why we combine robust capital markets research, expert portfolio construction and comprehensive risk management to craft innovative and efficient solutions that deliver targeted investment outcomes.

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