Talk Your Book: JP Morgan's Long-Term Capital Market Assumptions

0:00Today's Animal Spirits Talk Your Book is brought to you by J.P.Morgan.com slash LTCMA2026. and that will bring you to their JPMorgan Long-Term Capital Market Assumption Report that we're going to talk on the show today. That's jpmorgan.com slash LTCMA2026.

0:22Welcome to Animal Spirits, a show about markets, life, and investing. Join Michael Batnick and Ben Carlson as they talk about what they're reading, writing, and watching. All opinions expressed by Michael and Ben are solely their own opinion and do not reflect the opinion of Ritholtz Wealth Management. This podcast is for informational purposes only and should not be relied upon for any investment decisions. Clients of Ritholtz Wealth Management may maintain positions in the securities discussed in this podcast.

0:51Welcome to Animal Spirits with Michael and Ben. On today's show, we talk to Gabby Santos. Gabby is the Chief Market Strategist for the Americas at J.P. Morgan. and every year for the past 30 years, JP Morgan has done this capital assumptions thing where they look at putting out forecasts for inflation, GDP growth, interest rates, stock market returns around the globe. And I think it's an interesting exercise because I got a call, I got an email just the other day from an advisor. We said, hey, I'm going through my financial planning software and trying to put capital market assumptions in and they have one way of doing it.

1:25My firm has another way of doing it. What do you think is the best way to do it? and I think that there probably is no right or wrong way to do it as long as you're reasonable. But I think the important thing is, is that you update these on a regular basis to take into account the changing landscape, the valuations, the interest rates, the past returns, all this stuff. So I think that exercise is helpful, but the idea that anyone is going to get these perfectly right is probably not realistic. Yeah. So I think as you're thinking about the discovery process for thinking about long-term returns.

1:59I think just the exercise of growing through the process and the paper that we referenced today is seeped in that. I don't know. Is it 80 pages? It's a lot. So just going through that, thinking about the big themes that are going to drive returns over the next 30 years is an interesting thought exercise for sure. And we went through with Gabby the whole process that they go through to determine these. And it's not a science. It's more of an art than anything, but I think you use the past as a guide and then you use the present to sort of update your priors on the past with the understanding that you can't predict the future.

2:33So anyway, I just think it's a good exercise for all investors to go through in terms of setting expectations. We've done this work in the past where you think about or you visualize rolling returns for various asset classes, 60, 40, whatever it is. And the shorter your time frame, obviously, the greater the variability. When you zoom out to 30 years, and of course, nobody lives in 30-year increments as an investor, but it is remarkable how relatively stable long-term returns have been. So I've done this recently. The volatility of stock market returns over 30 years, like the range of returns is lower than it is for cash and bonds.

3:10Wow. Wow. Pretty impressive, right? Anyway, we get into all this and more with Gabby Santos from JP Morgan. Here's our talk with Gabby now.

3:22Gabby, welcome to the show. Thank you so much. Thanks for having me. All right. This is an incredible report. We're so excited that we are able to talk about it with you today. Obviously, a lot of resources and hours go into this, so we appreciate you taking the time. I'm going to start here. There are a lot of competing forces in the world of investing today. And you so aptly named the report, Shifting Landscapes and Silver Linings. So let's start here. Economic nationalism, which you all say can constrain global growth, but also accelerate domestic investment. Obviously a push and pull there.

4:06How are you all thinking about the shifting landscapes of that through the investment lens? Yeah, that's a great place to start because we do think there are three interconnected themes. These are not new to this edition. These were themes we've been gaining more and more conviction over the years, and then even more this year with a lot of policy change around the world. So we've got economic nationalism. We've got fiscal activism and CapEx build-out. And we've got AI innovation and adoption. And they all kind of feed on themselves. So if we think about economic nationalism, clearly there's a lot of frustration around the world, rising inequality, forgotten areas and sectors.

4:50And that's driving this focus to more investment domestically, production domestically, domestic labor force. For that, you do need to make sure that you're actually investing with this combination of public and private money to be able to finance the build out of certain industries like manufacturing in the US, rare earths, semiconductors. You need also a lot of private capital behind that. There's also this additional force of AI, a lot of innovation and adoption that's fueling even more capex, public and private. And that gains even more urgency if your labor force is starting to shrink and or get more expensive.

5:35So we see it all feeding on each other. And that's what I love about this report is, you know, we're not reacting to the news of the day or the month. These are all themes that have been building. I think they just gained even more urgency this year and truly are global phenomena. This is not just a description of forces in the US. So I want to get into some of the forces, but I thought it'd be interesting to take a step back because you guys are doing these long-term capital market assumptions. And it sounds like JP Morgan has been doing this report for about 30 years now. I got a question from an advisor recently who said, hey, I'm trying to figure out how to set expectations for my own clients when I do this.

6:12So what is the process that you all go through to do this? Because obviously there are estimates here and there's educated guesses. But in a lot of ways, it is a guessing game because we don't know what's going to happen. The 2020s is a great example of that. So how do you go about setting these forecasts with the understanding that we don't know what's going to come next? Yeah, so the punchline at the end of the book are forecasts, efficient frontiers, projected returns, volatility, correlations. But I think it's really the buildup to those numbers that's particularly useful for clients. So it's thinking about, all right, from one year to the next, what have we learned that's truly new rather than just something that ends up moving the market that day or that week?

6:56And that way you're building a framework, a north star of where you think things are going, and you're incrementally adding to it. In terms of the process also, we take into account not just long-term forces, but also how the markets have moved and priced all of this in. So we take the starting valuation into account, the forces that we think are the most important for each building block, macro, fixed income, equities, private markets, correlations and volatility, a lot of stress testing with each other and thinking about different shocks that could arise along the way. And then that's how we end up coming up with the final numbers and with the final portfolio construction recommendations and discussions.

7:43So I would focus less on the specific basis points for setting expectations, but more the general discussion around starting valuations, forces, and then the kind of numbers that we're talking about. And this is all over, on average, 10, 15 years. So it's never meant to be a forecast for next year. It can be a lot better or a lot worse. But having that at least a certain guidepost for people when they're planning for retirement, where they're coming up with strategic allocation, I think it's helpful. And then we tweak it around the edges as the year goes on with tactical allocation too. I feel like in the last, I don't know, five years or so, inside the stock market, it's been a lot of the same story prior to this hyperscaler CapExPen that we're spending so much time talking about.

8:36It was questions like, will value investing ever work again? Are the large cap dominance, will that ever mean avert? And this year seems to be the year where we're having some fundamental stories that are really impactful. So the last couple of decades, what you can describe part of the story as global economic cooperation. And we are at what feels like an inflection point with retrenching, reshoring, domestic manufacturing. Obviously, the administration has a large focus on that. I love this quote in your piece from Michael Semblis. He said, It is shocking how little geopolitics actually matters to markets unless it gets truly terrible.

9:17And wholeheartedly agree there. But do you think that a lot of the policies that we're seeing are going to matter more in the future? Or is it really going to be more of the same where it's listening? It's earnings and it's inflation and everything else is noise. That's a big question. So that was a bad tee up. So I think on a month-by-month basis, geopolitics and all these forces, they really don't matter for the day-to-day of the markets unless there's really that peak rise in uncertainty like we had April this year with Liberation Day around tariffs. And then we just really didn't know exactly what businesses and economists and households should plan for.

10:01But I think in those three forces we teased out for these long-term capital market assumptions, that's where we can embed where maybe it does matter on the underlying structure. So, for example, economic nationalism, that's something we see showing up more in our inflation estimates. So if all of a sudden you're building your supply chains not based on where it's cheapest and you can have the fattest margins, but based on considerations that local governments have, just diversification of supply chains, national security. So that's one where maybe we need to think a little bit about how this can be ultimately passed on to end consumers.

10:48So we do see a little bit of an uptick in our long-term inflation estimates. That's where that protectionism, economic nationalism is showing up. We do also see it showing up in yield curves. Steeper yield curves is a big theme for us. So forget the weird post-financial crisis, pre-pandemic period. We're now projecting a return to the kind of yield curve steepness we used to have pre-GFC. And then third, what about just inflation or rate to volatility? And that's where we're projecting stock bond correlations to continue to move higher and just be more unpredictable. So that the main conclusion is diversifying the diversifiers.

11:34Let's not, you know, pin all our hopes and dreams on bonds. They'll work sometimes when it's about a recession or that kind of traditional shock we were used to there for 20 years, but they're not going to work when it's more geopolitical, related to inflation or fiscal. Then you need other stuff that's uncorrelated to stocks and bonds and hopefully both as well to mix in there. So you had your 60-40 portfolio. I think the outlook was like 6.4 % for a 60-40 portfolio. And then you also mentioned there's a 60-40 plus portfolio because you bring some privates in. So maybe you could explain to us what that 60-40 plus portfolio is, and then some of the other diversifiers you use there.

12:15Yeah, and I'm sure, as you guys know, we use 60-40 as kind of like, let's just mix in some public stocks and bonds. But that really hasn't delivered the kind of returns and experience, right, that clients want for a few years now, and especially after 2022, when both stocks and bonds sold off at the same time. And we just think it's a feature, not a bug, of this investing landscape because of all of these forces, that sometimes that stock bond mix just won't be enough. So part of it is diversifying the diversifiers. That could include things like gold. That could include things actually like active management, which is uncorrelated to just how the markets are behaving.

13:00And a big part of that is including private markets. So the types that are unrelated or uncorrelated, for example, to bonds. So infrastructure, real estate, transportation, absolute return hedge funds, all a really big part of that. The discussion around alternatives is also to improve returns, right? Because capital markets have changed. So for example, if the idea is to invest in small companies to really generate growth, we've really trimmed down our small cap premium. Like it's basically the same as large cap. So where are you going to find that these days? It's private markets. It's venture capital.

13:43It's private equity. It's even infrastructure, very related to this whole AI, CapEx, build out and adoption. So really, we're trying to retire the 60-40 and go back to a new idea of a 60-40 plus. Where do you think we are in the evolution of private markets such that the premium diminishes such that we've seen in other areas of the markets that you mentioned? Because there is a lot of money coming in. And I am probably of the mentality that not that this necessarily ends badly and buyer beware and you're going to get crushed with the vultures trying to sell you their illiquid bags. I'm not there.

14:26I'm not quite that cynical. However, I do think that as money pours in to an asset class that was previously restricted, has a liquidity premium, I do think that returns are going to be lower than they were historically. I don't think that's super controversial. I'm not calling for end of the world or anything quite that dramatic. But where do you think we are in that evolution? Do you think it's still early? And you could use private credit because that's all the rage these days. a, depending on how you measure it, a one and a half,$2 trillion asset class, still significantly smaller, obviously, than corporates and treasuries, like, duh.

15:05But is there, like, how big do you think this can get before we start seeing those diminishing returns? And I know there's like a million, you know, caveats and nuance in there. Yeah. And I know, and that's something actually our institutional clients worry about. For some of them, they have 30, 40, 50 % in alternatives, depending if you're a pension or an endowment. And that is something that they see, look, all of this retail, private wealth money, what does this mean for us in terms of expected returns? And I think we're still early days in a lot of the asset class specific alternatives within our piece.

15:42Actually, if anything, we're a bit more optimistic about. That's the ones that derive a lot of their premium from alpha, which has been really pressured the last few years, the last decade. And if anything's improving. But you're spot on, Michael, that the one place to look is private credit. And we did lower our return forecast from last year for private equity by 50 basis points. There's just a lot more competition, whether it's all kinds of private credit funds, all kinds of fundraising that's happening. Banks might be coming back into some corporate lending, especially the higher quality. And that leads to just spreads getting tighter and tighter and tighter.

16:24And we're seeing that. And as a result, lower returns. And you're seeing that. And we do expect that to continue. I think that's one place. That's the place to look at the moment is really private credit and what you really expect from that going forward. But still a lot of value-add areas we're more optimistic about is the alpha component helping private equity again now that capital markets are open. Price discovery is happening again, especially for tech and AI-related names. Infrastructure is another area that we're all talking about the build-out of infrastructure, but they're going to be winners and losers.

17:05And we do think some are better positioned to capitalize on the whole rising electricity demand story. Real estate, some pockets still soggy, under pressure versus others where there's more of a structural tailwind. And then lastly, absolute return hedge funds. So for them, a bit of a dream to have a little bit more macro uncertainty and shift in correlations happening beneath the surface. How much harder is it to offer the forecast for these private markets? because a lot of these asset classes are still relatively new, haven't been through a lot of different cycles. They're more illiquid, so the marks don't happen as often.

17:41So it's harder to know the types of cycles these things could go through. So how challenging is that when you're trying to come up with the forecast for this stuff? So I think private market data full stop is really challenging, especially if you're trying to do apples to apples. So number one is just, you know, we do a lot of due diligence on what the best benchmark is, where there aren't a bunch of issues around survivorship bias. For example, only the best companies are taken into account. The other thing is we need to make sure they're all net of fees so that we're truly getting the same experience.

18:19And then you have to make a judgment call. So we tend to look at the median manager, knowing that there's going to be some that really shoot the lights out and some that really underperform. So we start there and we work with the data we do have, the history we have, or try to come up with proxies, for example, for private credit to try to backfill some of the data. And then the last thing we do around volatility is we de-smooth the data. So we try to get rid of that illusion that everything's nice and smooth sailing in private markets because there's no mark-to-market happening as much. So we try to get at the heart of what's the economic volatility.

19:04For example, private equity is a great example, right? When you have smaller companies, there is some tie to what's happening in the economic cycle, although that might not show up in the kind of mark-to-market you're seeing. So that way we hope to get a more representative number and one that's more properly adjusted for volatility. And even there, when we look at a 60-40, we had quoted 6.4%. And then we think about, well, how much would alternatives help? If you're, let's say, an institutional client, you're adding 30%, it would help that return improve to 6.9 % and just improve your Sharpe ratio by about 25%.

19:44And then we show variations. If you're earlier on, maybe it's just 10 % or 20%. Obviously, the magnitude goes down, but still same direction of travel for the improvement in your outcome. One of the big themes that investors have been discussing that seemed to reach a fever pitch in December was this idea that US stocks would outperform international just forever and ever. It seemed really difficult to make a fundamental case why international markets should outperform other than simply mean reversion. Like, fine, that's always there. Typically, you need some sort of a catalyst. Maybe this year was a weakening dollar, which hard to foresee.

20:26But here we are in 2025. For the first nine months of the year, we have the largest outperformance of international stocks versus US equities. Do you think that this is sustainable or is this yet again another blip in a long-term divergence between the two areas? Yeah, we were really heartened to see that finally happen because it's been coming up in these long-term capital market assumptions for a while now, saying the dollar is overvalued, we expect the dollar to weaken, so that would boost that international return idea, as well as valuations in the U.S. are the most elevated and needs some sort of penalty or subtraction from long-term returns versus other markets a bit less.

21:15And then we finally did have that catalyst. You know, imbalances persist until they don't. And then you can get a massive correction, this huge outperformance of international, biggest since 2009, biggest weakening of the dollar since 1973. So it's tough to have been too disheartened and caught completely off guard for this kind of normalization that happened this year. Now, if we look going forward in our numbers, there are different flavors of U.S. exceptionalism. We do still expect the rest of the world to outperform the U.S. over the 10, 15 years, but still about the starting points. Still the currency a bit too expensive by about 10%, we think.

22:02And still the U.S. having the biggest drag from the multiple, about two percentage point annualized drag. Wait, can we just pause there for a sec? So you expect the US to lag or to underperform international markets over the next 10 to 15 years. I just want to pause on this for a second because that is a big statement that might or might not come true. But I think that a lot of listeners are probably not positioned for something like that. What do you think would be the main drivers outside of the currency? Is valuation the big one? Valuation's the big one. And the market was expensive last year.

22:39That was a big theme for us in the LTCMAs. It's even more expensive this year. We haven't had the starting price-to-earnings ratios for U.S. large cap since the early 2000s. And we like to say that valuations tell you nothing about returns the next year, but they do tell you a lot more about the kind of returns you should expect over this kind of window, the 10-15. I think it's really worth saying it's not a reversion to the mean. We do expect the fair PE to be higher than the long-term average in the U.S. because we just keep getting more and more profitable companies with amazing return on equity, very high margins.

23:23But still, some normalization, and that ends up shaving off a little bit from long-term U.S. earnings by two percentage points a year versus the rest of the world, nothing's dirt cheap. Everything's actually a little bit expensive. It's just got less of a drag. If you look at just secular returns, though, outside of starting PEs, starting currency, the U.S. is exceptional. There's no comparison for the kind of return on equity, the kind of earnings growth that we're able to generate here. Actually, the only one that compares is India. But outside of that, if it wasn't for where we're coming from, the U.S.

24:03should outperform. We just have a final little normalization that needs to happen here. And I got the numbers here. I think you have the ETH at 7.5 % and the U.S. at 6.7%. So it's still pretty close. So when you have these discussions, is there any thought? Because Michael and I talk about this all the time. Like, what if the U.S. just deserves higher valuations now? Because these companies are bigger and better and have better margins and they're cash flow producing machines. What if this just is the new normal valuations? Sometimes when you say that stuff, it almost feels silly because you go, no, every time this is that before, the valuations get too high.

24:36Eventually, they need to come down a bit. The MAG-7 makes up 35 % of the market now. And if these companies stay large, there's a lot of ifs here. But is it possible that this is just a new permanent plateau? I'm taking the 1929 saying here. Do you give any credence to that possibility? We definitely do. And we did some work a few years ago on just resetting our equilibrium valuations for the U.S. because of the change in composition. It is a lot more tech. It is a lot more profitability, especially coming through very elevated margins. So I thought I was pulling this up just to give some numbers, like some flavor to this.

25:19We like, for this purpose, using last 12 months PEs, the long-term average using last 12 months, the last 20 years, is a PE of 18 times. We don't think we'll go back to 80 times. It should be higher. We think the equilibrium is 19.2 times. We are currently at 25 times. So I think it's really exactly, it's not reversion to the mean, it's reversion to the trend. where it is a higher PE over time, but still too elevated to start things off. And there's a little bit of a drag there that's coming. And same for margins, right? It's also reversion to trend, not to median. They're just a little bit elevated right now versus the long-term equilibrium.

26:09One of the drivers of, or not one of, the driver of higher multiples, higher margins, are these tech giants that we spend too much time talking about, but it is the elephant in the room. One of the areas where they're having a big impact outside of just the valuation and the equity and all that sort of stuff is inflation or deflation. So how do you think about the tug of war between the fiscal stimulus that we've seen and the supply chain breaking because of reasons that are well understood at this point. How do you think about future inflation, fiscal spending versus AI innovation pulling down prices?