Projecting long-term returns

One silver lining of March’s market downturn is, almost across the board, price corrections have created opportunities.

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“All markets in our investment universe have become more attractive than they were in January,” said Éric Morin, senior analyst at CIBC Asset Management, in a late-April report assessing long-term capital market returns.

The outlook for portfolios was uninspiring earlier this year due to how overvalued many asset classes were, a CIBC report from January said. But dislocations in various markets due to Covid-19 are sowing “the seeds of investment opportunities,” Morin said in a late-April interview.

One thing hasn’t changed: in both the January and April reports, Morin predicted that emerging market bonds and equities are likely to be top performers based on possible 10-year average expected returns that could reach double digits.

Canadian equities may not be too far behind, based on the research, while U.S. equities aren’t expected to perform much better than most bonds.

Still, Morin is cautious. “In a world of low growth and low interest rates, it’s more difficult to find opportunities [for] return than usual,” he said.

As the global situation evolves, Morin will rely on two levels of analysis.

He first ranks asset classes, with valuation as the “key pillar” for attractiveness.

“We compare current market prices with their respective long-term fair value [and] rank the deviation across countries in order to identify undervalued and overvalued assets,” he said.

The long-term value estimate is derived from a long-term projection of expected returns, which takes demographic trends, economic productivity, long-term debt and policy rate projections into account, Morin said.

The second step is conducting country-specific qualitative research. While a country could rank well and appear undervalued from the first step, he noted, “it could have important external funding vulnerabilities which could reduce our appetite for this asset class.”

Between May and July, he’ll be looking at three things.

First, Morin will look for signs that the Covid-19 outbreak is stabilizing.

“It will be important to look at the pace at which the virus will be spreading,” he said.

The second is the policy response. “We want to see if [governments and central banks] will continue to pledge that they will deliver whatever it takes for the economy,” he said, which would lower the risk premiums for risky assets.

Finally, he’ll be looking for economic confirmation of expectations.

“We have to look at key cyclical and forward-looking indicators, such as the PMI indexes or new orders,” he said. “You need a green light from those indicators before taking more risk on board.”

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