Capital Market Expectations 2025: Slowing but not sinking

About capital market expectations (CMEs)

Every year we review the data that drive capital markets—current valuation measures, historical risk premia, economic growth and inflation prospects—to provide the foundation for our forecasts. We update the models that we use and review their continued appropriateness. Crucially, our models are based on first-principle economic relationships and reflect seasoned practitioner judgment.

We continue to include as part of every capital market forecast a measure of the expected volatility of that asset class, informed by long-term observed standard deviation of returns. Given that changes to global central banks’ quantitative easing policies may have repressed both equity and bond market volatility over past years, but increased turbulence more recently, our approach to modeling volatility reduces recency bias and is particularly appropriate at a time when many leading central banks have moved to normalized policy.

Our CMEs are designed to provide annualized return expectations over a longer-term horizon, typically viewed as 10 years. Specifically, we calculate geometric mean return expectations over a 10-year period, which both fully captures the average length of a US business cycle and aligns with the strategic planning horizon of many institutional investors.¹

Our modeling approach is based on a blend of objective inputs, quantitative analysis and fundamental research, consistent with the skill set of our Franklin Templeton Investment Solutions (FTIS) business. Underpinning these inputs are assumptions on the sustained growth rates that developed and emerging economies can expect to achieve and the level of price inflation they will likely experience. This approach is forward-looking, rather than being based on historical average returns. This is especially important in an evolving macroeconomic environment.

Summary

We believe riskier assets, such as global stocks and corporate bonds, have greater performance potential than global government bonds, given our expectation of moderate global growth and a continued normalization in global inflation expectations.

• We believe that maintaining a diversified multi-asset portfolio, in addition to the traditional benefits of a balanced portfolio between stocks and bonds, is the most likely path toward stable potential returns.
• Global interest rates have moved lower over the year but remain elevated relative to the previous decade. Overall return expectations from fixed income assets are slightly reduced from those anticipated in our 2024 CME forecasts, but remain higher than foreseen during most of the past decade.
• The risk premium within corporate bond yields appears to be broadly adequate compensation for the likely level of default risk across the business cycle, but the low starting spread level makes it more likely that prospects will be challenged in the near term.
• Earnings growth and yield will likely drive equity returns, however, with the twin headwinds of valuations reverting to their long-run means and significant recent gains our 10-year horizon expectations have moderated since last year.
• Over the 10-year horizon used for our CMEs, we see a constructive environment for asset returns and a relatively healthy alternative risk premia.
• We expect the US dollar to depreciate versus most developed market currencies as our valuation metrics suggest it is overvalued.