Asset allocation outlook 2024

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.

Key takeaways

As prospective returns have risen, so has the cost of sitting on excess cash.


That makes this a good time to consider building a new or adding to an existing core portfolio.


It’s also a good time to revisit the basic principles of a core portfolio construction. That includes taking a professional approach, restoring bonds to their traditional role as anchor and diversifying within and across asset classes.

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. 

Wise investors have a strong core

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.

Figure 1: Returns for US large caps, 10-Year US Treasury bonds and the 60/40 stock/bond allocation during years when bonds and equities fell in tandem (and consequent one- and two-year forward return for the 60/40 allocation)

Year

US large cap total return YoY % change

10-Year total return YoY % change

60% US large cap

40% 10-year US Treasury

1-Year forward 60/40 return

2-Year forward 60/40 retun

1931

-43.9

-2.6

-27.3

-1.8

28.0

1969

-8.5

-5.6

-7.3

10.0

24.2

2022*

-18.1

-17.0

-17.7

4.6

 

Source: CGW Global Asset Allocation and Quantitative Research Team, Global Financial Data (GFD). S&P 500 TR is used for US Large Cap index and US 10-Year Govt. Bond TR (Provider: GFD) is used for the 10-Year Total Return. The historical allocation levels use indices and are provided for informational purposes only. The historical index allocation levels should not be taken as an indication of future performance, which may be better or worse than the levels set forth above. The index returns shown do not represent the results of actual trading of investor assets. The indices are unmanaged. An investor cannot invest directly in an index. They are shown for illustrative purposes only and do not represent the performance of any specific investment. Index returns do not include any expenses, fees or sales charges, which would lower performance. Past performance is not necessarily indicative of future returns. Real results may vary.

 

* For 2022 line, 1-Year Forward 60/40 return is YTD performance as of October 31, 2023.

The pandemic was an aberration

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. 

Our Strategic Return Estimates for 2024 

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. 

Figure 2: Long-term outlook for asset classes – Our Strategic Return Estimates (SREs)
 

2024 SRE

2023 SRE

2022 SRE

Global Equities 

8.70% 

7.60% 

4.20% 

Developed Market Equities 

8.20% 

7.00% 

3.80% 

Emerging Market Equities 

12.80% 

12.90% 

8.10% 

Global Fixed Income 

5.80% 

5.10% 

2.00% 

Investment Grade Fixed Income 

5.40% 

4.60% 

1.80% 

High Yield Fixed Income 

7.90% 

7.40% 

2.60% 

Emerging Market Fixed Income 

8.10% 

7.80% 

3.60% 

Cash 

4.30% 

3.40% 

0.90% 

Hedge Funds 

11.50% 

9.10% 

4.10% 

Private Equity 

19.50% 

17.60% 

11.60% 

Real Estate 

10.90% 

10.60% 

8.80% 

Commodities 

2.70% 

2.40% 

1.50% 

Source: CGW Global Asset Allocation and Quantitative Research Team. Strategic Return Estimates (SREs) for 2024 based on data October 2023, prior Strategic Return Estimates for 2023 (based on dataas of October 2022) and 2022 (based on data as of October  2021). Returns estimated in US Dollars. All estimates are expressions of opinion and are subject to change without notice and are not intended to be a guarantee of future events. Strategic Return Estimates are no guarantee of future performance. Past performance is no guarantee of future returns. Strategic Return Estimates based on indices  are Citi Global Wealth’s forecast of returns for specific asset classes (to which the index belongs) over a 10-year time horizon. Indices are used to proxy for each asset class. The forecast for each specific asset class is made using a proprietary methodology that is appropriate for that asset class. Equity asset classes utilize a proprietary forecasting methodology based on the assumption that equity valuations revert to their long-term trend over time. The methodology is built around specific valuation measures that require several stages of calculation. Assumptions on the projected growth of earnings and dividends are additionally applied to calculate the SRE of the equity asset class. Fixed Income asset class forecasts use a proprietary forecasting methodology that is based on current yield levels. Other asset classes utilize other specific forecasting methodologies.

SRE do not reflect the deduction of client fees and expenses. Past performance is not indicative of future results. Future rates of return cannot be predicted with certainty. Investments that pay higher rates of return are often subject to higher risk and greater potential loss in an extreme scenario. The actual rate of return on investments can vary widely. This includes the potential loss of principal on your investment. It is not possible to invest directly in an index.

All SRE information shown above is hypothetical not the actual performance of any client account.  Hypothetical information reflects the application of a model methodology and selection of securities in hindsight.  No hypothetical record can completely account for the impact of financial risk in actual trading. 

The shine returns to Alternatives

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. 

Using Strategic Return Estimates and asset allocation to build core portfolios

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. 

Figure 3: Bonds are back – potential return generation opportunities for 2024

Source: CGW Global Asset Allocation and Quantitative Research, and Bloomberg. Analysis as of October 31, 2023. Rate hike refers to an increase in the Federal Funds rate. Rate hike dates included in this analysis are from February 1995, May 2000, June 2006 and December 2018. The chart on the left shows the average of the cumulative total unhedged returns for the stated indices over the 12 months following the four aforementioned rate hike dates. Treasury bills are represented by the Bloomberg US Treasury Bill Index. 1-5yr treasury is represented by the Bloomberg US Treasury 1-5 years Index. 5-10yr treasury is represented by the Bloomberg US Treasury 5-10 years Index. 10+yr treasury is represented by the Bloomberg US Long Treasury Index. The indices are unmanaged. An investor cannot invest directly in an index. They are shown for illustrative purposes only and do not represent the performance of any specific investment. Index returns do not include any expenses, fees or sales charges, which would lower performance. Past performance is not necessarily indicative of future returns. Real results may vary. 

3. Within equities, diversification is a benefit

Beyond diversifying among stocks, bonds and alternatives, it is also important to diversify within asset classes – especially equities. This means diversifying geographically as well as across sectors and market capitalization. 

Here is an interesting data point to consider: the UK and Brazilian domestic equity markets currently each have approximately a 1% weighting to the information technology (IT) sector. When you compare that to IT’s recent 22% weighting in the global equity benchmark, it is easy to see how a more intentional regional diversification could help to temper losses the next time a “tech rout” has other global investors seeing lots of red.

In a similar vein, no one knows exactly when EM equities will again start outperforming developed equities, or when US small caps will go on their next streak – but by maintaining a well-diversified equity portfolio investors can increase the probability that their results may eventually benefit from rallies as they occur. After all, to keep your core portfolio as your bedrock requires professional guidance to search for investment opportunities that leaves no country unexplored and no stone unturned. 

A cash conundrum 

Holding excess portfolio cash that greatly exceeds levels needed to meet unexpected expenses may be seen as tempting in turbulent times, but the feeling of security it conveys can be transient and costly over time. As our new 10-year Strategic Return Estimates have risen over the last two years across all asset classes, we are bullish about the long-term investment landscape. We are therefore encouraging clients to follow asset allocations based on their risk profile and consider adding to long term core portfolios as appropriate. 

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