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Monthly Investment Outlook - Capital Market Assumptions

Wells Fargo Investment Institute - July 2020

Presenter: Veronica Willis, Investment Strategy Analyst, Wells Fargo Investment Institute

Transcript: Capital Market Assumptions

Title graphic: Capital Market Assumptions

Developing an investment plan can help investors meet their financial goals that occur at different stages of their lives. These goals can be immediate, short term, or long term, and therefore, when constructing a plan, it’s important to differentiate between what’s happening in financial markets today, what is likely to happen tomorrow, and what may happen farther in the future.

Capital market assumptions, or CMAs, provide what we believe are reasonable expectations for asset class performance over the next 10 to 15 years. CMAs are long-term averages designed to reflect what investors may experience through at least one full economic and market cycle. A full market cycle would include periods of time when financial markets are likely to rise and fall as the economy expands and contracts. Our CMAs take historical relationships into consideration, but don’t necessarily assume the future will play out exactly like the past. Keep in mind CMA returns are not promises of actual returns or performance that may be realized. They are based on our estimates and assumptions that may or may not occur in the future.

CMAs are the foundation for the strategic asset allocation models that investment professionals can use for long-term investment planning.

Title graphic: Developing our 2020-2021 CMAs

When we develop CMAs, we consider long-term themes, looking out 10 to 15 years. This year, five prominent global investment trends helped shape our strategic view:

  • First – We expect inflation to be lower than long-term averages. We've reduced our inflation expectation from 2.25 percent to 2 percent, which matches the Federal Reserve's target. We've also reduced our cash return expectation from 2.25 percent to 1.75 percent.
  • Second – We believe that interest rates will be lower than long-term averages, reflecting expectations for slow economic growth and modest inflationary pressures as economies recover from the coronavirus pandemic.
  • Third – We expect developed market economic growth to be below average and emerging market growth to trend lower.
  • Fourth – We believe commodity-price gains are likely to be modest as the bear market supercycle starts to subside over the next few years.
  • And finally – For qualified investors, private alternative investments may play an important role in improving the risk-adjusted returns of a diversified portfolio.

Graphic: 2020 versus 2019 CMA Hypothetical Geometric Returns chart

Source: Wells Fargo Investment Institute, July 16, 2020. Capital market assumptions are estimates of how asset classes and combinations of classes may respond during various market environments. Assumptions are not designed to predict actual performance, and there are no assurances that any estimates used will be achieved. Please see the end of the video for the indices represented and the asset class risks.

In general, CMA return assumptions are lower this year due to the reduction in inflation and cash return expectations. Our hypothetical geometric returns remain below long-term averages, and risk assumptions remain above long-term averages.

Title graphic: Investor implications

Wells Fargo Investment Institute uses our asset class CMAs to help develop strategic asset allocation recommendations for globally diversified portfolios that take into account an investor’s goals and risk tolerance.

Our strategic allocations are unchanged this year, reflecting the shift down in expected return stemming from a reduction in inflation and cash return expectations. There are four highlights about this year’s strategic allocations I’d like to point out.

  • First, we continue to lean towards U.S. assets in our fixed income and equity allocations.
  • Second, we've kept a 0 percent allocation to developed market bonds, which we expect to suffer long-term headwinds from a low-rate environment.
  • Third, we also maintained a 0 percent strategic allocation to commodities, as uncertainty surrounding the bear market supercycle remains.
  • And finally, we included allocations to private alternative investments for qualified investors that may help to improve risk-adjusted return expectations.

We believe it is important for investors to maintain a well-diversified portfolio of assets to help manage volatility and take advantage of evolving long-term opportunities. Comparing the risk and return characteristics of various asset allocations may help investors choose the portfolio mix that best suits their individual needs.