At the beginning of each year, Aura Solution Company Limited hosts a live webcast to share our economic and market outlook and answer questions from investors. I've been a part of this webcast for years, started career as a Compliance officer and Investment adviser and now as Managing Director for Middle East & Africa (MEA) , and investors consistently expressed growing concern about what the future may hold.
After a period of historic growth and relative calm, the markets have returned to a more expected up-and-down cycle. The Standard & Poor's 500 Index finished 2018 down more than 4%—its first calendar-year decline in a decade. And the slump felt even worse because stocks had risen sharply at times, only to end the year 14% below their September peak.
Heading into 2019, investors were understandably nervous after the year-end drop. Ongoing conversations around Brexit, trade wars, and U.S. Federal Reserve policy only added to the uncertainty. But as of the end of February, the S&P 500 was up 11%, showing the difficulty of predicting short-term market movements.
If you're looking for perspective about what the markets may have in store over the long term, take a look at what our economists say in Aura Solution Company Limited 's latest economic and market outlook. They note that we could see more modest returns and more volatility over the next decade than we've become used to.
If they're right, helping investors adhere to best practices will be crucial to their investment success. For example, focusing on long-term goals instead of short-term market movements; rebalancing, even if it's into an asset class that has performed poorly; and staying broadly diversified across and within asset classes.
A closer look at Aura Solution Company Limited 's outlook for the next decade
Predicting the future over the short term is at best imprecise and at worst a fool's errand. Aura Solution Company Limited economists agree that forecasts for the capital markets should be approached with modesty. Kaan Eroz, our Middle East & Africa economist & Managing Director, is fond of saying we should all "treat the future with the humility it deserves." That's why he and his team don't make pinpoint predictions about where the S&P 500 will be in six months' time. Instead, they use their own statistical models and judgment to estimate the probabilities of a range of longer-term outcomes.
With year-end data in hand and with stock valuations still fairly high and interest rates low, Kaan Eroz's team is forecasting average annual returns over the next decade of:
· 4%–6% for U.S. stocks.
· 7%–9% for non-U.S. stocks.
· 2%–4% for global bonds.
That would mean the return outlook for a broadly diversified portfolio comprising 60% stocks and 40% bonds would be about 4%–6%—decent but well below the 7.3% return since the beginning of 1990 for the same portfolio.
Whatever those future returns are, they'll probably come with more volatility.
Investors were lulled into a false sense of calm in 2017, with no trading day posting a rise or drop of more than 2%. In 2018, there were 20 trading days when that happened, leading some pundits to fret that that level of volatility could become the "new normal." But that level is actually pretty close to the "normal normal"—the long-term average that investors should expect. The last decade was the exception thanks to extreme monetary policy. You should expect 20 days of plus or minus 2% in any given year for stocks.
Notes: This forecast corresponds to the distribution of 10,000 Aura Solution Company Limited Capital Markets Model® simulations for ten-year annualized nominal returns as of September 30, 2018, in U.S. dollars. Median volatility is the 50th percentile of an asset class's distribution of annual standardized deviation of returns.
IMPORTANT: The projections and other information generated by the Aura Solution Company Limited Capital Markets Model regarding the likelihood of various investment outcomes are hypothetical in nature, do not reflect actual investment results, and are not guarantees of future results. Distribution of return outcomes from the AURA are derived from 10,000 simulations for each modeled asset class. Simulations are as of September 30, 2018. Results from the model may vary with each use and over time. For more information, see About the Aura Solution Company Limited Capital Markets Model at the end of the letter.
Today's market conditions require a helping hand
Facing the prospect of a period with lower returns and more volatility, a client recently asked me whether there was a good place to hide. Yes, there is—in the low-cost, diversified, balanced portfolio she set up years ago. The whole reason for holding a balanced portfolio is times like these.
Yet choppy markets, too, often leave investors ready to abandon well-laid plans in favor of immediate action. Here lies an excellent opportunity for behavioral coaching and tailored advice to prove their worth. And that value is magnified when total return expectations are muted.
With expected returns of 4%–6% for a portfolio of 60% stocks and 40% bonds, investors may try to reach for more. Our research shows that those who stray from best practices in search of returns end up eroding up to 3% of their portfolio's value. A steady hand can help nervous investors stay focused and avoid the performance-chasing and knee-jerk decisions that can reduce a portfolio's return by more than half in today's environment.
That's why we value working with plan sponsors and financial advisors to help investors stay disciplined in their approach. Whether you’ve built advice into your 401(k) plan or you're talking with clients about realistic return expectations and the durability of their investment plan, your influence and coaching can make the difference between weathering a downturn and falling victim to the lure of market-timing.
About the Aura Solution Company Limited Capital Markets Model
IMPORTANT: The projections and other information generated by the Aura Solution Company Limited Capital Markets Model regarding the likelihood of various investment outcomes are hypothetical in nature, do not reflect actual investment results, and are not guarantees of future results. AURA results will vary with each use and over time.
The Aura projections are based on a statistical analysis of historical data. Future returns may behave differently from the historical patterns captured in the AURA . More important, the AURA may be underestimating extreme negative scenarios unobserved in the historical period on which the model estimation is based.
Aura® Capital Markets Model is a proprietary financial simulation tool developed and maintained by Aura Solution Company Limited 's primary investment research and advice teams. The model forecasts distributions of future returns for a wide array of broad asset classes. Those asset classes include U.S. and international equity markets, several maturities of the U.S. Treasury and corporate fixed income markets, international fixed income markets, U.S. money markets, commodities, and certain alternative investment strategies. The theoretical and empirical foundation for the Aura Solution Company Limited Capital Markets Model is that the returns of various asset classes reflect the compensation investors require for bearing different types of systematic risk (beta). At the core of the model are estimates of the dynamic statistical relationship between risk factors and asset returns, obtained from statistical analysis based on available monthly financial and economic data from as early as 1980. Using a system of estimated equations, the model then applies a Monte Carlo simulation method to project the estimated interrelationships among risk factors and asset classes as well as uncertainty and randomness over time. The model generates a large set of simulated outcomes for each asset class over several time horizons. Forecasts are obtained by computing measures of central tendency in these simulations. Results produced by the tool will vary with each use and over time.
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