Approach

The principle is to consider typical eight-year returns based on where we are in the economic cycle.

A classical view of the economic cycle is that the economy moves through four stages, growth; economic overheat, requiring intervention from central banks to temper inflation; contraction requiring economic stimulus to get the economy back on its feet; and then recovery as stimulus is scaled back. In real-life the economy can move backwards or skip a stage compared to this simplified representation.

Market returns can also be impacted by events that fall outside of this cyclical macro-economic behaviour. Covid-19 was one such example which led to the global economy cycling very quickly through contraction and back into overheat.

Whilst stock market crashes are possible at all stages of the economic cycle, they are more likely to be deeper and felt wider across the economy when the cycle moves from overheat into contraction.

Position in the economic cycle

Inflation remains supply-side driven, originating in pandemic disruptions and amplified by the war in Ukraine, tariffs, and current Iran-related risks. Trump’s “emergency” tariffs were ruled unlawful by the Supreme Court in February, but the administration is already pursuing alternative routes to maintain trade pressure. Rising energy demand linked to AI is compounding inflation pressure in the US. At the same time, US consumer sentiment has fallen to one of its lowest points in decades, highlighting weak confidence at a point where policy stability is critical. Instead, institutional uncertainty is increasing, with continued pressure from Trump on Fed Chair Powell and questions around Kevin Warsh’s independence raising concerns over policy credibility ahead of mid-term dynamics. While fundamentals still underpin (muted) expansion, the key risk is a cost-driven ‘overheat’. We have weighted our analysis as 67% growth, 33% overheat.

Estimating returns

The return for cash is the SONIA overnight rate for cash expressed as an annualised return.

For assets in the Fixed Income asset classes, we used the latest eight-year yield to maturity as the annualised return for each of the sub-asset classes. This is to avoid any arbitrage opportunities within the market return estimates.

For Equities and remaining asset classes, our market data from 1971 is partitioned into four economic stages – Growth, Overheat, Contraction and Recovery. Then we have calculated annualised risk and return for each index over rolling two-year and eight-year periods. The analysis is done net of UK inflation. We have then added back in current expectations of eight-year UK inflation to give a return expectation based on current inflation expectations and a probabilistic weighting of where we are in the economic cycle.

Manual adjustments to reflect efficient market pricing

Some risky asset classes do not fit on a neat risk return spectrum, such as the FTSE All-Share AIM historical risk, and Emerging Market historical returns. For example, FTSE AIM exhibits moderate volatility and very poor historical downside events. Conversely, Emerging Markets has high volatility but low historical returns. For parity, we adjusted FTSE AIM risk upwards in line with observed downside performance. The Emerging Market equity returns were adjusted upwards to be in line with a capital asset pricing model (CAPM), in essence this means that an investor would expect to be compensated with more return for taking on more risk in Emerging Market equities.