After a rare down year for both stocks and bonds in 2022, returns were mixed in 2023.

The upside has been a reset of valuations across asset classes – and a promising setup for the decade ahead, according to our proprietary framework.

In our opinion, this is a good time to build new core portfolios or to add to existing ones. The two pillars of investment returns – income and growth – appear reinvigorated. For the first time in many years, prospective returns across all major asset classes look promising. Our 10-year Strategic Return Estimates (SRE) for the elements of global portfolios have increased from two years ago. 

Of course, such forecasts are just that: forecasts fluctuate with changing conditions over time. A shock that drives inflation higher (or more quickly lower, for that matter) is just one of the unexpected developments that could alter the patterns we foresee. But based on where the data stands now, bond yields look attractive to us. Fixed income should be able to anchor portfolio returns while providing diversification and resilience going forward. Yields have risen toward two-decade highs. As inflation abates, today’s “real” after-inflation yields of 2.5% could be hard to come by. 

US equity valuations are more attractive now. Global equity valuations have improved, too. Many sectors trade at moderate valuations. Accordingly, we have already increased our exposure to global equities for core portfolios and are likely to continue to add more over the months to come.

The setup for alternative assets is also promising, adding to our positivity about the opportunity set as we enter 2024.

After euphoric returns in 2020 and 2021, markets suffered in 2022 and had mixed results through 2023. This set-up suggests that a return to normal is ahead of us. As the economy slows, then grows, we expect markets will begin to anticipate the positive news we see ahead. 

Core portfolios are a bedrock for wealth management. Maintaining exposure to growth and income through a balanced allocation to traditional and (for certain investors) nontraditional asset classes allows a portfolio to benefit from economic development, help minimize losses and potentially beat inflation. These are key to accumulating and sustaining wealth over time. 

Typically, the returns for the two largest parts of the core – stocks and bonds – tend to offset one another, with stocks doing better in years that bonds struggle and vice versa. But in 2022, stocks and bonds sold off. That’s just the third time in the last century this has happened.

The previous times that both sides of the classic “60/40” stock/bond allocation sold off were in 1931 and 1969 (Figure 1). Two years later, entering 1934 and 1972, core allocations had risen by more than 20%. While no one knows how we will enter 2025 after a dismal 2022, the opportunities for both equities and bonds appear ahead of us as we write Wealth Outlook 2024.

The pandemic was one of the most disruptive events in human history yet was accompanied by one of the strongest bull markets on record. While this was cheered at the time, it created massive price distortions across major asset classes.

With interest rates persisting at zero and extensive interventions by governments and central banks, the valuations and relationships between securities was distorted. High-risk securities in zero rate environments attracted risk capital. Low-risk assets were overlooked by many investors as speculation ran rampant.

We think of the inflationary spike and sharply restrictive monetary policies of 2022 and 2023 as the punishment applied to markets to correct those aberrations. They were also a reset that cleared out the speculators and restored asset prices to more temperate and ultimately more sustainable levels. 

We cannot be sure of the exact timing (so patience is key), but we’re confident (at least as confident as we can be) that a return to normal is coming. 

According to Adaptive Valuation Strategies (AVS), our proprietary strategic asset allocation methodology, our Strategic Return Estimates for all the major asset classes are higher than they have been for several years (Figure 2).

The 10-year SRE for global equities stands at 8.7% (Figure 2). Within that, we are estimating that developed market (DM) equities will average a return of 8.2%, rising from 7.0% in last year’s estimates. We are also forecasting growth in DM corporate earnings, which should help to keep valuations at reasonable levels and sustain those share price gains.

On the flipside, emerging market (EM) equities experienced a setback in both prices and earnings in 2023, leading to a higher valuation. As a result, we forecast a slight decline in SRE from 12.9% to 12.8%.

Investment grade fixed income 10-year forecast now shows an SRE of 5.4%, marginally higher than last year’s. Similarly, high yield fixed income also enjoys cheap valuation, which offsets tightening spreads, bumping the decade-ahead high yield SRE to 7.9%. Our forecast for EM fixed income has increased marginally to 8.1% as spreads have tightened. 

When it comes to the alternative asset classes, our research has shown that the Strategic Return Estimates for hedge funds and private equity highly correlate with small- and mid-cap public equities. This helps explain why, with small- and mid-cap (SMID) stocks historically cheap, the strategic return estimate for hedge funds has risen to 11.5% and private equity to 19.5% – the highest of all the asset classes. 

While private equity forecasts are attractive, it is important to balance this richer potential with the illiquid nature and high downside risk of the investments as well. Still, there are reasons to believe the asset class now presents potential opportunities for qualified investors.

We cover this in more detail in Alternative Investing in 2024, and also provide more context on the regulatory backdrop contributing to this potential in Investing with and in unregulated financial companies.

Although real estate valuations cheapened, the broader income profile is not improving, especially in the commercial segment. The SRE for real estate has, therefore, edged up only slightly to 10.9%, reflecting reduced rates over the next decade. Commodities ticked up slightly as well, to 2.7%, roughly in line with marginally higher expectations for inflation over the long-term. 

At Citi Global Wealth we use these forecasts to build our asset allocation models, along with each asset class risk level, that help form the basis of our clients’ core portfolios. AVS adapts to changing market conditions and recognizes that future returns are strongly affected by current valuations. 

There are three principles that govern how we build core portfolios today.

1. The importance of asset allocation and embracing a professional approach

Following an asset allocation plan is one of the most important decisions you can make as an investor.

The core elements of your portfolio should include bonds, equities and (depending on your asset level, risk and liquidity preference) alternatives. Hedge funds add diversification and often experience more contained drawdowns during volatile markets (though certainly come with their own downside risks related to illiquidity and the potential use of leverage). In addition, a mix of private equity and real estate can enhance returns and help further outpace inflation (albeit with potentially even greater liquidity constraints).

2. Bonds anchor returns and seek to mitigate portfolio risk

We began to emphasize the improving value of bonds last year. With rates moving even higher in mid-2023, we acknowledge that our initial enthusiasm came a bit early. But now with higher yields, significantly lower inflation and the interest rate hiking cycle peaking in the US and other key regions, we like bonds even more for 2024. While we cannot be certain of the Fed’s actions, historically, the periods following the end of hiking cycles have seen strong investment returns, especially for longer duration Treasurys (Figure 3).

Looking at the portfolio risk equation, high-quality fixed income may help to lower overall portfolio volatility. Leaving 2022 (and 1969 and 1931) aside, such assets can usually be counted on to deliver positive returns exactly when needed – during periods of severe market stress associated with equity drawdowns. Going forward, given compelling valuations and peaking policy rates, fixed income can once again play both parts of its role, delivering attractive returns while mitigating portfolio risk.