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From dramatic shifts in the US presidential race, to the Yen carry trade, to uncertainty around Fed policy, the last few months have felt like a period of significant change.  Financial markets saw their most volatile period in August with the S&P 500 falling 8%, only to recover those losses by month’s end.  

But for long-term investors, have things really changed that much? As a trusted fiduciary, one of our main roles is to help investors cut through all the noise and focus on what’s important. These events, while noteworthy, are just part of the broader financial landscape we navigate.

Annual Review of Capital Market Assumptions

Once a year, we conduct a review of our key assumptions about markets. As markets change, so do our views around long-term expected returns. We don’t try and predict markets, but we do perform an annual review of our capital market assumptions — 10-20 year forecasts of how different asset classes could perform based on global economic, monetary, and political conditions. Each year’s review includes active discussions and healthy debates among the Ellevest Investments team to determine whether market change: 1) is material and 2) requires action. In some years, we finish our capital market assumptions review and make little change to our forecasts. In others, we make more active adjustments to our portfolios. 

This year is not one of those active adjustment years. The data from the past 12 months (below) reveals a relatively stable economic environment. While we've made slight downward revisions to equity return expectations and some peripheral fixed income segments (Emerging Market & High Yield), our overall outlook remains largely unchanged. This makes sense, as these “risk assets” have rallied over the past year and the only major difference is that valuations (the price investors pay for earnings) have increased.

While our focus is on the long-term, we're not ignoring important influences such as potential changes to Fed policy or the impact of artificial intelligence (AI). These factors are part of our ongoing analysis, but they haven't significantly altered our long-term projections. Here’s some insight into how we’re incorporating these into our current thinking.

Fed Policy

The market has been anticipating Fed interest rate cuts throughout the year. However, the timing has been pushed back due to persistent inflation and a stronger-than-expected labor market.

A big reason investors pay so much attention to a change in Fed policy is that it indicates a new regime — one that is less restrictive and more accommodative to financial markets. Also, simple historical analysis like this one typically shows stocks and bonds performing well after a pivot. 

Typically, when the Fed starts its path to lowering interest rates, it does so quickly — mainly because the Fed is typically doing so to help boost an economy that’s in recession. The last two occurrences, the 2020 pandemic and 2008 financial crisis, are good examples of this.  

However, unlike previous rate-cutting cycles, the Fed isn't currently battling a recession.  Economist Ed Yardeni outlines a case for such a scenario by explaining how the economy may not be as interest rate sensitive as it has been in the past. He goes as far as to say, “There is no need to rush to lower interest rates rapidly, as was necessary in the past after something broke in the financial system.”

The conclusion? Interest rates may stay higher for longer, even if the Fed starts a pivot to lowering interest rates. That could mean benefits for bond investors looking to lock in higher yields as well as diversified investors who have seen a return of the 60/40 portfolio’s effectiveness.

Artificial Intelligence

Another focus for investors has been the rise of artificial intelligence. In the near term, user adoption hasn’t quite met expectations; however, that hasn’t stopped investors from piling into big tech names (like Nvidia), which has led to more market concentration. We’ve written about these risks in the past, and here’s another example of why this phenomenon doesn’t typically last. TLDR: If you’re a long-term investor, just know that the top companies that dominate markets and lead to market concentration typically don’t hold their top spots forever. 

Longer-term, AI is still expected to provide massive efficiency gains — which should lead to additional productivity improvement and, thus, further GDP growth. However, this is also expected to be a longer-term phenomenon. JP Morgan expects productivity gains to take up to seven years to materialize.  

We remain optimistic about AI's potential but encourage investors to align their goals and time horizons with realistic prospects for AI investing. For example, while consumer adoption hasn’t quite lived up to expectations, commercial adoption seems underway.  We’ve also seen great opportunities within private markets, including venture-backed companies utilizing AI in health care to infrastructure investments leveraging AI to advance energy transition.

Despite the headlines and short-term volatility, the fundamental economic landscape has remained relatively stable over the past year. Long-term investors should bear this in mind, as we enter a period of increased political and policy uncertainty.

To learn more about Ellevest and how we help our clients build their wealth with a values-aligned investment strategy, you can schedule a call with us here.

Disclosures