PGIM Quantitative Solutions
May 29, 2019
PGIM Quantitative Solutions seeks to help solve complex investment problems with custom systematic solutions across the risk/return spectrum.

QMA's Q2 Capital Market Assumptions

Global Economic Outlook:

We expect real economic growth in the developed economies to continue to moderate over the next decade, as it has for the last 30 years. Growth of the developed labor force is limited by domestic demographics, with no assumption for a significant offset from improved productivity growth. Inflation in developed markets, in contrast, is anticipated to increase modestly over the next 10 years, relative to the low rates of inflation observed since the onset of the global financial crisis of 2008. We expect real economic growth and inflation in emerging markets to advance at higher annualized rates. Younger populations and higher rates of return on capital in emerging markets are driving higher rates of nominal economic output compared to developed market peers.

Equities:

Our 10-year annualized nominal return forecast for global equities is 6.9%, compared to 7.9% at the end of 2018, which reflects richer valuations at the end of the first quarter coincident with global equities1 advancing 12.2% to open the year. Our long-term return forecast for US equities is somewhat lower, at 6.1%. Developed market equities outside the US are forecast at 8.3%, a differential largely accounted for by lower historical valuation ratios outside the US. Our long-run forecast for emerging market equities is 7.6%, with higher rates of nominal economic growth offset somewhat by comparably lower expected income returns than in developed markets and a negative
expected valuation adjustment.

For more insights visit: qma.com/insights

2019 Q2 CAPITAL MARKET
ASSUMPTIONS
For Professional investors only. Not for use with the public.
All investments involve risk, including the possible loss of capital.
2019 Q2 Capital Market Assumptions
Summary
Global Economic Outlook:
We expect real economic growth in the developed economies to continue to moderate
over the next decade, as it has for the last 30 years. Growth of the developed labor force is limited by domestic
demographics, with no assumption for a significant offset from improved productivity growth. Inflation in developed
markets, in contrast, is anticipated to increase modestly over the next 10 years, relative to the low rates of inflation
observed since the onset of the global financial crisis of 2008. We expect real economic growth and inflation in
emerging markets to advance at higher annualized rates. Younger populations and higher rates of return on capital in
emerging markets are driving higher rates of nominal economic output compared to developed market peers.
Equities:
Our 10-year annualized nominal return forecast for global equities is 6.9%, compared to 7.9% at the end
of 2018, which reflects richer valuations at the end of the first quarter coincident with global equities
1
advancing
12.2% to open the year. Our long-term return forecast for US equities is somewhat lower, at 6.1%. Developed market
equities outside the US are forecast at 8.3%, a differential largely accounted for by lower historical valuation ratios
outside the US. Our long-run forecast for emerging market equities is 7.6%, with higher rates of nominal economic
growth offset somewhat by comparably lower expected income returns than in developed markets and a negative
expected valuation adjustment.
1
As measured by the MSCI ACWI Net Total Return Index.
US Treasury Bonds
Global Treasury Hedged
US Aggregate Bonds
Global Aggregate Bonds H
edged
US Investment Grade Bonds
US High Yield Bonds
US TIPS
US Equities
US Small Cap
UK Equities Unhedged
Europe x UK Equities Unhedged
Japan Equities Unhedged
Developed International x
USA Equities Unhedged
EM Equities Unhedged
Global Equities Unhedged
US REITs
Developed REITs Unhedged
Commodities
0.00
1.00
2.00
3.00
4.00
5.00
6.00
7.00
8.00
9.00
10.00
0.00
5.00
10.00
15.00
20.00
25.00
Expected Geometric Return
Expected Volatility
Source: QMA as of 3/31/2019.
3
2019 Q2 Capital Market Assumptions
For professional investors only. Not for use with the public.
Fixed Income:
After falling sharply to close 2018, global sovereign interest rates declined further in the first quarter of 2019, resulting
in a reduction in long-run forecast returns for fixed income investments generally from the end of 2018. With a very low starting point for
initial income returns, our long-run forecast for unhedged global aggregate bonds is 1.3%, declining from a 2% forecast at the end of 2018.
Our long-run forecast for US aggregate bonds is 3.1%, consistent with higher initial yields in the US. Over the next 10 years we expect
the US central bank’s policy rate to average approximately 2.8%, approximately 0.4% higher than the current policy rate. Outside the
US, developed market central banks are forecast to modestly increase policy rates, as some policy normalization is expected. In US credit
markets, we are forecasting modest upward adjustments in average spread levels over the next 10 years, contributing to expected returns of
3.4% and 5.3% for US investment grade and high yield bonds, respectively.
Real Assets:
Real assets are broadly defined to include asset classes that have physical properties or returns that are highly correlated with
inflation. We include commodities, REITs and TIPS as real assets in our Capital Market Assumptions (CMAs). Our 10-year expectation is
that returns for each of these asset classes will exceed the forecast rate of US inflation.
Currency and Currency Hedging Returns:
Over the next 10 years we are forecasting a modest decline of the US dollar relative to
developed market peers, ranging from an annualized forecast gain of 0.1% for the euro to a forecast annual appreciation of 0.9% for the
Japanese yen. Emerging market currencies, in contrast, are expected to depreciate against the US dollar over the next 10 years. With short-
term interest rates expected to be higher in the US over the long term than in other developed markets, long-term currency hedging returns
in developed markets are forecast to be positive for US investors.
Overview
QMA’s CMAs underpin the long-run outlook for strategic
allocations in our individual strategies and multi-asset
portfolios. They are the product of a highly systematic
process for generating consistent projections across the
capital markets.
CMAs provide 10-year forward-looking expectations
for the most widely held equity, fixed income and non-
traditional asset classes, measuring both return and
risk. We update our views each quarter. Our investment
professionals begin with evolving asset class fundamentals
and macroeconomic assumptions at the country level. For
each asset class, we decompose local return expectations
into three broad categories: income, growth and
valuation adjustment. We also forecast relative currency
adjustments for investors in different domiciles to allow
for conversion to hedged or unhedged returns. Our core
building blocks and final forecasts are reviewed at their
component levels by an investment council of our most
senior investment professionals.
Global Economic Outlook
Forward-looking views for economic growth and inflation are some of the most critical building blocks for our CMAs. We currently
compile these for 16 nations. Based on our forecasts, real economic growth in the developed economies over the next 10 years is expected
to continue to moderate, as it has for the last three decades. The growth of the labor force is limited by domestic demographics, with no
assumption for a significant offset from improved productivity growth. We expect economic growth in developed economies to be led
by Australia and other countries with younger populations and more liberal immigration policies. Growth is expected to be slowest in
Japan and parts of Western Europe where the labor force is expected to contract further over the next decade. We anticipate inflation in
developed markets to increase modestly over the next decade relative to the last, ranging from a forecast 2.5% annual rate in Australia
to a low of 1.4% in Japan. In emerging markets, rates of real economic growth and inflation are expected to exceed those in developed
markets. We expect growth and inflation to average 4.4% and 2.9%, respectively, driven by emerging markets’ younger populations and
higher rates of return on capital.
Shown for illustrative purposes only.
Source: QMA.
Capital Market Assumptions Framework
A
sset Class Specific
Inputs
Current Equity
Market Valuations
Dividend Yields
10-year Treasury Yield
Credit Spreads
Macro Inputs
GDP Growth
GDP Potential and
Inflation Forecasts
Investment Council Review
of Primary Inputs
Including GDP Growth and
Inflation Expectations
Equilibrium Valuation and
Real Interest Rates
Capital Market Return Expectations
Global and Integrated Across Regions
Internally Consistent Across Assets
Guided by Investment Council
Economic Assumptions
Future Real Interest
Rate Forecasts
Real Rates
Future
Valuation Forecasts
GDP Growth
Credit Spread
Forecasts
4
2019 Q2 Capital Market Assumptions
For professional investors only. Not for use with the public.
Interest Rates
Country
Current
Short-Term
Interest Rate
Forecast
Short-Term
Interest Rate
United States
2.38
2.79
United Kingdom
0.80
1.67
Eurozone
-0.31
1.51
Japan
-0.17
1.44
Australia
1.39
2.47
Canada
1.67
2.06
2
GDP weighted Eurozone country average for European Central Bank.
Global Fixed Income Markets
Long-term fixed income forecasts begin with our view of 10-year forward policy rates for each of the major developed market central
banks. We derive expected policy rates for each central bank jurisdiction as a function of current and future equilibrium real interest
rates, the expected GDP output gap over the next 10 years
2
and the expected rate of inflation. For the US, policy rates over the next
10 years are expected to average about 0.4% higher than the 2.4% policy rate prevailing at the end of the first quarter of 2019, given
the forward view of inflation and growth relative to potential, which advanced modestly from the end of 2018. This follows a period of
approximately 2.3% in interest rate increases initiated by the Federal Reserve beginning in December 2015 and concluding in December
2018. Other developed market central banks are expected to raise rates, on average, consistent with forecast inflation rising closer to
central bank targets over the next 10 years.
For longer maturity government bond returns, we forecast each country’s expected long-term slope to define a term structure of
yields across their respective government yield curves. The forecast slope for each country is a function of forecast and potential
real economic growth and will evolve countercyclically. When economic growth is forecast below potential, the slope of the yield
curve is expected to be steeper (early cycle), whereas if growth is forecast to be closer to, or above potential (late cycle), the yield
curve is forecast to be flatter.
Our bond return forecasts are largely predicated on income and valuation factors. At a given maturity point, the forecast income return
for a government bond will consist of the average expected coupon yield over the forecast horizon, as well as proceeds from bonds
maturing to lower yields. Changes in yield at a given maturity point over the forecast horizon will determine the necessary valuation
adjustment. If yields are forecast to rise (fall) over the next 10 years, the valuation adjustment will be negative (positive).
After a decline in US 10-year yields of 0.7% over the last two quarters, yields for the US Treasury Index are expected to rise modestly
over the next 10 years, resulting in a negative valuation adjustment and an expected return of 2.6%, a decline of 0.9% from the end of
2018. Developed market government bonds outside the US are forecast to return less over the next decade, given lower initial yields and
a negative valuation adjustment as yields are expected to rise over the forecast horizon. Long-run returns in global treasuries for a US
investor are forecast at 1.3% on an unhedged basis and 2.2% on a hedged basis, given future forecast short-term interest rate differentials.
Source: Bloomberg, QMA, as of 3/31/2019.
5
2019 Q2 Capital Market Assumptions
For professional investors only. Not for use with the public.
Decomposition of Fixed Income Return Forecasts
3.49
2.43
2.77
0.85
2.53
2.9
0.39
0.37
0.93
2.78
-0.85
-1.46
-0.11
-0.10
-0.10
-0.38
1.21
1.21
-2
-1
0
1
2
3
4
5
6
7
US Treasury
Global Treasuries
Hedged
US Aggrega te
Global Aggregate
Hedged
US Investm ent
Grade
US High Yie ld
Benchmark Ra te Income
Spread Income
Valuation Adjustment
Currency Hedging Return
We calculate the expected returns for fixed income credit
indices to include any additional income expected from an
average credit spread yield over comparable government
bonds, adjusted for expected default and downgrade
losses over the forecast horizon. We then calculate the
valuation adjustment for expected changes in spreads.
Our long-term forecast for US aggregate bonds is 3%, which includes an
expected spread return of 0.4%. Our forecast for hedged global aggregate
bonds from a US investor perspective is 2.3%, given similar assumptions
for credit spreads and defaults, as well as the aforementioned lower
starting levels for underlying government yields outside the US. For both
US investment grade and high yield bonds, spreads at the end of the first
quarter of 2019 are judged to be somewhat lower than expected averages
for the next 10 years, after notable declines in the first quarter. Long-run
returns for US investment grade and high yield bonds are expected to be
3.4% and 5.3%, respectively.
Global Equity Markets
Decomposition of Global Equity Return Forecasts
3.54
2.98
2.31
3.25
1.70
1.32
4.37
1.86
2.25
1.72
2.91
2.16
-1.32
1.72
-1.13
-0.38
0.27
-0.85
-4
-2
0
2
4
6
8
10
12
US
Developed x USA Equities
Unhedged
EM Equities Unhedged
Global Equities Unhedged
Income
Real Earnings Growth
Inflation
Valuation Adjustment
Currency
2.64%
2.18%
3.05%
2.33%
3.36%
5.30%
6.12%
8.28%
7.61%
6.93%
Source: QMA as of 3/31/2019.
Source: QMA as of 3/31/2019.
6
2019 Q2 Capital Market Assumptions
For professional investors only. Not for use with the public.
Consistent with historical precedent and assuming the continuation of
current dividend taxation regimes, the US equity market has a large share
of expected income returns coming from buybacks equal to about 1.6%
in our long-term forecasts. Outside of the US, the expected impact of net
share issuance on long-term income returns is anticipated to be a modest
drag of 0.3%. For emerging markets, an expected drag on income returns
from net share issuance is forecast at 0.8%.
For the growth component of our equity return forecasts, long-term
nominal earnings growth for each equity market is expected to approximate
the growth in nominal GDP for each country. We calculate this as the
combined annualized rate of expected inflation plus real GDP growth. Our
10-year forecast for US real annualized GDP growth is 1.7%, with 2.3% for inflation, translating to an earnings growth component of
4%. For developed markets outside the US, our 10-year expectation for real GDP growth is 1.3%, while inflation is expected to average
1.7%, providing nominal earnings growth of 3.0%, a decline of 0.2% from the end of 2018.
For emerging markets, higher nominal GDP growth relative to developed markets is expected to result in long-run nominal earnings
growth of 7.3%.
The significant advance in global equities in the first quarter of 2019, taking the MSCI ACWI to a year-to-date gain of better than
12%, has resulted in a negative adjustment in expected returns for global equities in general. Among developed markets, however, only
the US has a negative expected long-term valuation adjustment -- 1.3% per year -- attributable to historically elevated valuation ratios.
Developed equities outside the US, in contrast, are expected to benefit by 1.7% annually, given what are still relatively cheap historical
valuation ratios. Emerging markets equity returns are forecast to be 1.1% per year lower on negative valuation adjustments.
Real Assets
We include commodities, REITs and TIPS as real assets in our Capital Market Assumptions. Our 10-year expectation is that the returns
for each of these asset classes will exceed the forecast rate of US inflation.
For US TIPS, we assume that expected inflation and break-even inflation converge over time, implying that the inflation risk premia and
liquidity risk premia in TIPS offset each other. Under these assumptions we forecast a long-term return from TIPS of 2.8%, which is
slightly above the expected return to US Treasuries, given the slightly higher duration of US TIPS. This US TIPS forecast is a decline
of 0.9% from the end of 2018, on a greater estimated negative valuation adjustment from higher future long-term real interest rates.
Despite better than 10% returns in the first quarter of 2019, valuations for both US and Global REITs are still judged to be inexpensive
relative to longer-term expectations, resulting in an expected positive valuation adjustment of 0.4% for both US and Global REITs,
after adjusting for lower future dividend yields. Our long-run forecast for both US and Global REITs is 6.8%. This is a decline from a
forecast return greater than 8% for both US and Global REITS at the end of 2018, when valuation adjustments contributed even more
positively to expected returns.
Our long-run expected return for commodities is 3.7%, reflecting a return on cash of 2.6% (assuming investment through liquid futures)
and a growth premium of 1.1%, consistent with historical spot returns over cash. This forecast is a 0.3% increase from the end of 2018,
primarily attributable to an increase in the expected return to cash.
All of our long-term asset class forecasts, including equities, are based on income, growth, and valuation considerations.
To build the income component of our long-term
equity forecasts, we calculate each country’s expected
income contribution, based on current and future
anticipated levels of dividend yield, as well as the
expected returns attributable to anticipated buyback
activity (positive) or net positive share issuance
(negative).
7
2019 Q2 Capital Market Assumptions
For professional investors only. Not for use with the public.
2.82
4.09
4.19
2.58
2.25
2.16
1.14
0.39
0.37
0
1
2
3
4
5
6
7
8
TIPS
US REITs
Global REITs
Commodities
Income
Growth/Inflation
Valuation Adjustment
Currency
QMA Q2 2019 10-Year Capital Market Assumptions
Asset
Expected Geometric
Return
Expected Arithmetic
Return
Expected
Volatility
Expected
Sharpe Ratio
Cash
2.58
--
--
--
US Treasury Bonds
2.64
2.74
4.48
0.04
Global Treasury Bonds Hedged
2.18
2.40
6.58
-0.03
US Aggregate Bonds
3.05
3.21
5.56
0.11
Global Aggregate Bonds Hedged
2.33
2.48
5.43
-0.02
US Investment Grade Bonds
3.36
3.57
6.43
0.15
US High Yields Bonds
5.30
5.65
8.31
0.37
US TIPS
2.82
2.97
5.55
0.07
US Equities
6.12
7.23
14.83
0.31
US Small Cap
6.62
8.47
19.20
0.31
UK Equities Unhedged
8.98
10.55
17.73
0.45
Europe x UK Equities Unhedged
7.46
8.91
17.06
0.37
Japan Equities Unhedged
8.35
10.54
20.97
0.38
Developed International x USA Equities Unhedged
8.28
9.53
15.82
0.44
EM Equities Unhedged
7.61
10.38
23.55
0.33
Global Equities Unhedged
6.93
8.82
19.47
0.32
US REITs
6.75
8.23
17.25
0.33
Developed
REIT
s Unhedged
6.81
9.17
21.70
0.30
Commodities
3.73
4.77
14.40
0.15
Decomposition of Real Asset Return Forecasts
2.82%
6.73%
6.80%
3.72%
Source: QMA as of 3/31/2019.
Source: QMA as of 3/31/2019.
Currency and Currency Hedging Returns
Our long-term return forecasts for currency and currency hedging are based on our forward views of local relative price levels and
short term policy rates. These views allow us to provide our long-term forecasts for a range of domiciles outside the US. Over the next
10 years, we are forecasting the US dollar to decline modestly relative to developed market peers, ranging from an annualized forecast
gain of 0.1% for the euro to a forecast annual appreciation of 0.9% for the Japanese yen. Emerging market currencies, in contrast, are
expected to depreciate against the US dollar over the next 10 years. With short-term interest rates expected to be higher over the long
term in the US than in other developed markets, long-term currency hedging returns in developed markets are forecast to be positive
for US investors.
About
QMA
QMA began managing multi-asset portfolios for institutional investors
in 1975. Today, we manage systematic quantitative equity and global
multi-asset strategies as part of PGIM, the global investment management
businesses of Prudential Financial, Inc. Our time-tested processes, based on
academic, economic and behavioral foundations, serve a global client base
with $122 billion in assets under management as of 3/31/2019.
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herein. Any reproduction of these materials, in whole or in part, or the divulgence of any of the contents hereof, without prior consent of QMA is prohibited. QMA is the primary business name for
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information, assure its completeness, or warrant such information will not be changed. The information contained herein is current as of the date of issuance (or such earlier date as referenced
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The opinions and recommendations herein do not take into account individual client circumstances, objectives, or needs and are not intended as recommendations of particular securities,
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Certain information contained herein may constitute “forward-looking statements,” (including observations about markets and industry and regulatory trends as of the original date of this
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not rely on such forward-looking statements in making any decisions. No representation or warranty is made as to future performance or such forward-looking statements.
QMA affiliates may develop and publish research that is independent of, and different than, the recommendations contained herein. QMA personnel other than the author(s), such as sales,
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herein. Additional information regarding actual and potential conflicts of interest is available in QMA’s Form ADV Part 2A.
Asset allocation is a method of diversification that positions assets among major investment categories. Asset allocation can be used to manage investment risk and potentially enhance returns.
However, use of asset allocation does not guarantee a profit or protect against a loss.
QMA is a wholly-owned subsidiary of PGIM, Inc. the principal asset management business of Prudential Financial, Inc. (PFI) of the United States of America. QMA’s investment team operated
for many years within one of PFI’s asset management companies. QMA’s predecessors began managing domestic equity accounts for US tax-exempt clients in 1975. In 2004, QMA became a
registered investment adviser with the SEC under the Investment Advisers Act of 1940 and the quantitative management business of PGIM, Inc. was transferred to QMA. PFI of the United States
is not affiliated in any manner with Prudential plc, which is headquartered in the United Kingdom.
For financial professional use only. Not for use with the public.
Copyright 2019 QMA. All rights reserved.
QMA-20190508-188
Authors
Marco Aiolfi, PhD, Portfolio Manager,
Director of Systematic Multi-Asset Strategies
Yesim Tokat-Acikel, PhD, Portfolio Manager,
Director of Multi-Asset Research
Lorne Johnson, PhD, Portfolio Manager,
Director of Institutional Solutions
For More Information
To learn more about QMA’s global multi-asset solution strategies,
please contact Lorne Johnson, PhD, Portfolio Manager and Director of
Institutional Solutions, at
lorne.johnson@qma.com
or 973.367.4470.
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