The Challenge of Long-Term Investment Forecasting

While short-term market forecasts are often futile, long-term return assumptions are unavoidable for investors. Our model currently projects 20-year real total returns of approximately 7% per annum across a range of global equity markets. Surprisingly, this is not lower than historical growth trends; in many markets, it is slightly higher.

Given two dominant factors—current market levels and the widespread belief that future economic growth will be weaker—we explore whether these projections make sense.

Why Focus on a 20-Year Horizon?

Although our model generates return probabilities for multiple timeframes, 20 years is particularly significant. This is because:

• Secular trends in returns can affect both savers and retirees for decades.
• Long, sustained runs of strong or weak returns impact an investor’s entire financial plan.
• When modelling long-lived portfolios (e.g., retirement or trust funds), severe 20-year downturns are the most important stress tests.

Investors often set constraints on minimum tolerable outcomes, such as ensuring non-discretionary spending is always covered. A long period of poor returns can determine whether these constraints are breached.

Our Projections: What Do the Numbers Say?

Even over 20 years, the starting point of valuations matters. Our Fowler Drew model uses:

• Cumulative real total return indices (inflation-adjusted, dividend-reinvested).
• Regression-based trend analysis to assess whether markets are over- or undervalued.
• Mean reversion assumptions, which adjust projected returns based on deviations from trend.

Example: UK Market Projections

For the UK equity market, long-term real total returns have historically averaged 6.1% per annum. Because the current cumulative return is below its trend, our mean projected return is higher: 7.6% per annum.

Global Market Comparisons

Other major markets show similar trends:

• Most global markets are currently priced below their historical trend, leading to higher projected returns.
• The exception is the US market, where our mean projected return is 5.6% per annum, below its historical trend of 6.2% per annum.

This contradicts claims that US stocks are significantly overvalued—if they were, we would expect to see a much greater gap between observed returns and trend.

Currency Adjustments in Forecasting

Because exchange rates tend to mean revert over time, we also model expected currency effects:

• Based on inflation-adjusted exchange rate deviations since 1969.
• UK equities and sterling are currently among the cheapest assets globally.
• Currency-adjusted UK equity returns are even more favourable on a risk-adjusted basis.

These factors suggest that concerns about overvaluation in global markets may be overstated.

The Popular Narrative: Why Investors Expect Lower Returns

Many market commentators believe the next 20 years will be economically difficult due to several major shifts:

Factors That Could Depress Future Growth

1. The retreat of globalisation, leading to lower trade efficiency.
2. A declining global workforce, with ageing populations worsening dependency ratios.
3. High corporate and government debt, particularly after the 2008 financial crisis.
4. The long-term effects of pandemic-related fiscal and monetary interventions.

Possible Offsetting Factors

However, there are also structural trends that could mitigate these risks:

• Technological advancements increasing productivity.
• The transition to renewable energy, reducing economic reliance on fossil fuels.
• Efficiency improvements in emerging markets, where younger workforces continue to grow.

Many investors assume these forces will lead to structurally lower real returns. But are those assumptions justified?

The Disconnect Between Forecasts and Market Reality

1. Are Lower Returns Already Priced In?

If investors widely expect lower returns, markets should already reflect those expectations. However:

• The UK, emerging markets, and most global indices are not currently overvalued.
• The US market is above trend but not dramatically so.
• There is no obvious pricing discrepancy suggesting that markets expect extremely weak long-term returns.

In contrast, the Financial Conduct Authority (FCA)’s growth rate assumptions—which guide UK investment product forecasts—are far lower than our model's projections.

• FCA prescribed real return for equities: 5% per annum.
• Fowler Drew model: 7% per annum.

This difference is highly material over long time periods. The FCA’s forecasts appear to be based on broad economic concerns without adjusting for market valuation levels—a major oversight.

2. Forecasting Errors and Investor Biases

Historically, economic pessimism has often led to incorrect return forecasts.

• In the aftermath of the 2008 financial crisis, many analysts expected persistently weak stock market returns—yet the following decade saw above-average gains.
• Japan’s stock market was widely expected to underperform due to demographic and economic stagnation, yet real returns outperformed expectations due to corporate efficiency improvements and capital discipline.
• The US market was underweight in many institutional portfolios following the crisis but went on to outperform global peers.

This suggests that broad top-down economic concerns often fail to translate into weak equity returns.

3. How Inflation Affects Investment Returns

While lower growth does not necessarily mean lower equity returns, inflation risks are a real concern:

• Rising government debt may lead to inflationary policies to reduce real debt burdens.
• Labour market shifts and energy transitions could increase production costs.
• Central bank interventions may suppress nominal bond yields, reducing real returns from fixed income.

Currently, government bond markets do not price in high inflation risks, but historical patterns suggest that inflation could emerge suddenly and unpredictably.