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Equities achieved an impressive recovery following last year’s pandemic shock, and markets continue to trade near record levels. Both the S&P 500 index and S&P/TSX composite have returned about 12% year-to-date. However, investors may want to temper their return expectations going forward.

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“The big returns we saw last year in 2020 — and in the recent months as well — were driven by transitory factors,” said Éric Morin, senior analyst at CIBC Asset Management, in a recent interview.

Such factors include the news of successful vaccines against Covid-19 as well as ongoing fiscal support, both of which resulted in “bigger returns that we should not expect this year,” Morin said.

Further, “equity valuation is not cheap anymore,” which will also weigh on returns, he said.

While investors should expect more modest returns in upcoming years, certain macro forces will remain an important cyclical tailwind for equities.

For example, with recovery in only the early stages in many regions, the economy is far from overheating, Morin said. Also, “fiscal policy will remain growth-friendly, supported by central banks’ actions and low trend inflation,” he said.

In fact, Morin expects trend inflation, which excludes volatile and idiosyncratic factors, to be low over the next decade.

Though inflation will likely move higher in the near term, he said, that increase will be the result of transitory factors, such as strong demand and low inventories — a situation exemplified by the semi-conductor shortage — and higher oil prices.

His outlook of low trend inflation is supported by various trends.

“The relative cost of capital compared to labour has continued to decline since 2015,” Morin said. “So, it’s increasingly less expensive to invest in capital than [to] hire people.” Less hiring helps keep a lid on wages and consumer demand.

Further, “It’s increasingly possible to replace workers by machines, so the elasticity of substitution has increased over time,” he said.

Also, the relationship between excess demand and inflation has likewise declined, Morin said, referring to a flattening Phillips curve in recent decades as central banks have actively targeted inflation.

Because the connection between economic output and inflation is no longer strong, “in the case where the economy will eventually overheat, we should expect less inflationary pressure,” Morin said.

Many developed economies also have aging populations, which is associated with lower inflation.

With trend inflation thus expected to remain low, “central banks will remain comfortable to keep interest rates low over the long run,” he said. “And this will support a fiscal policy stance that will remain growth-friendly, and will provide a tailwind for equity.”

His return expectations are for most equity classes to deliver at least 5% on average over the next 10 years. By region, emerging Asia and emerging Europe will deliver average equities returns of about 9%, he said, and Canada and Europe, about 6% to 7%.

His return expectations for U.S. equities were more subdued, at below 5%, because of high valuations.

Equity investors should expect more volatility and regional heterogeneity when it comes to returns, Morin said: “The global reopening won’t follow a linear path.”

The IMF recently upgraded its GDP figures for such countries as the U.S. and China, the latter of which reported annualized growth in the first quarter of more than 18%.

“But as impressive as these stats are, many other countries are recovering at much slower rates,” said Kevin McCreadie, CEO and chief investment officer with AGF Management Ltd., in a recent blogpost. “It’s important that investors not get too far ahead of themselves by thinking growth rates of this magnitude are, by rights, sustainable.”

Other factors that may weigh on returns are the potential for near-term inflation volatility and for fiscal policy to be called into question, Morin said.

Faced with a more challenging environment for returns, investors shouldn’t ignore a fundamental investing principle.

“It will be important for investors to have good diversification in the portfolio — [both] geographical diversification as well as sectoral diversification,” Morin said.

This article is part of the AdvisorToGo program, powered by CIBC. It was written without input from the sponsor.