Investors have been on a rollercoaster over the last several months. Policies of the US administration aimed at reconfiguring the US trading relationships with the rest of the world led to a sharp selloff in the equity markets around the world, and then have markets quickly recovered most of the drawdowns.
This episode provides a good opportunity to evaluate how our Capital Market Assumptions navigated the volatility. For investors assessing the sharp selloff and how to position for a ‘buying opportunity’, how did expected returns across equities compare with the market rebounds?
As the equity selloff progressed, our estimates of short-horizon expected returns increased. This indicates that the declines in equities were not inflicting damage to long term outlook and that the increase in the equity risk premium was perceived as temporary by investors. For example, the short horizon expected return on S&P 500 index increased by around 200 basis points from the end of March to 7 April, while the index fell by more than 10%.
As part of our CMA solution, we estimate expected returns for equity markets across horizons, regions, sectors and styles. This allows us to evaluate how well the expected returns anticipated the subsequent rebound in equity markets. The chart below shows a scatter plot of short-horizon expected returns on 7 April 2025 – just before the equity markets bottomed out – and the subsequently realised returns up until 19 May 2025.
To the extent that our estimates of expected returns pick up fundamental differences in expected returns on different markets and segments, expected and realised returns should be positively correlated. In our case, the correlation between the expected and subsequently realised returns is 0.65 – a high number demonstrating how our estimates distinguished between more and less attractive tactical opportunities. US equities saw the largest increases in expected returns and the strongest rebound.
While the short-horizon expected returns jumped up significantly, the long-horizon (buy-and-hold) expected returns barely moved. The distinction between short- and long-horizon expected returns is only possible because we estimate expected growth, risk premiums and other components across all horizons required to impose present value consistency.
It might sound obvious, but in such volatile markets and drawdowns/rebounds occurring at a fast pace, we need to have high frequency expected return estimates. We are able to do this exercise because we produce Capital Market Assumptions at a daily frequency, which is relatively uncommon.
The recent episode illustrates how timely estimates of expected returns help investors guide their tactical decisions through volatile markets. Having estimates at the sector or style level gives further breadth to tactical positioning. Going through past selloffs (bear market) episodes paints a similar picture – our estimates of expected returns are reliable predictors on subsequently realised returns.