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

Episode Date: October 27, 2025

On this episode of Animal Spirits: Talk Your Book, ⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠Michael Batnick⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠��⁠⁠⁠⁠⁠ and ⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠Ben Carlson⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠ are joined by Gabby Santos, Chief Market Strategist for the Americas at JP Morgan to discuss the 30th annual edition of the firm's capital market assumptions report that covers stock returns, bond yields, inflation, GDP forecasts and more. Find complete show notes on our blogs... Ben Carlson’s ⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠A Wealth of Common Sense⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠ Michael Batnick’s ⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠The Irrelevant Investor⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠ Feel free to shoot us an email at ⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠[e-mail]⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠ with any feedback, questions, recommendations, or ideas for future topics of conversation. Check out the latest in financial blogger fashion at The Compound shop: ⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠https://idontshop.com⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠ Investing involves the risk of loss. This podcast is for informational purposes only and should not be or regarded as personalized investment advice or relied upon for investment decisions. Michael Batnick and Ben Carlson are employees of Ritholtz Wealth Management and may maintain positions in the securities discussed in this video. All opinions expressed by them are solely their own opinion and do not reflect the opinion of Ritholtz Wealth Management. See our disclosures here: ⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠https://ritholtzwealth.com/podcast-youtube-disclosures/⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠ The Compound Media, Incorporated, an affiliate of ⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠Ritholtz Wealth Management⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠, receives payment from various entities for advertisements in affiliated podcasts, blogs and emails. Inclusion of such advertisements does not constitute or imply endorsement, sponsorship or recommendation thereof, or any affiliation therewith, by the Content Creator or by Ritholtz Wealth Management or any of its employees. For additional advertisement disclaimers see here ⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠https://ritholtzwealth.com/advertising-disclaimers⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠. Learn more about your ad choices. Visit megaphone.fm/adchoices

Today's Animal Spirits Talk Your Book is brought to you by JPMorgan. Go to jp.morgon.com slash LTCMA 2026, and that will bring you to their J.P. Morgan long-term capital market assumption report that we're going to talk on the show today. That's JPMorgan.com slash LTCMA 2026. Welcome to Animal Spirits, a show about markets, life, and investing. Join Michael Batnik 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 Ridholt's wealth management. This podcast is for informational purposes only and should not be relied upon for any investment decisions. Clients of Ridholt's wealth management may maintain positions in the securities discussed in this podcast.

Welcome to Animal Spirits with Michael and Ben. On today's show, we talk to Gabby Santos. Gabby is a chief market strategist for the Americas at J.P. Morgan. And every year, for the past 30 years, JPMorgan 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 to 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. My 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. I think just the exercise of growing through the process and the paper that we

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. So 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. Wow.

Wow. Pretty impressive, right? Anyway, we get at all this and more with Gabby Santos from J.P. Morgan. Here's our talk with Gabby now. Gabby, welcome to the show. Thank you so much. 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. A lot of, obviously a lot of resources and hours going to 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. How 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 buildout, and we've got AI innovation and adoption. And they all kind of feed them themselves. So if we think about economic nationalism, clearly there's a lot of frustration around the world, rise in inequality, forgotten areas and second. and that's driving this focus to more investment domestically, production, 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 U.S., 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. So 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 our global phenomena, this is not just a description of forces in the U.S. So I want to get into some of the forces, but I thought it was interesting to take it to step back because you guys are doing these long-term capital market assumptions. And it sounds like J.P. 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. So 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? And 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. So 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 hyperscalor Kappexbend network spending so much time talking about. It was questions like, will value investing ever work again? Are the large cap dominance? Like, 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 Sambliss. He said, it is shocking how little geopolitics actually matters to markets unless it gets truly terrible and 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's noise? that's a lot that's a big question so 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 you know april this year with liberation day around around tariffs and then we just really didn't know exactly what businesses and economists and households should plan for but i think in 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. So 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-pendemic 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. Let's not 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 6040 portfolio. I think the outlook was like 6.4% for a 6040 portfolio. And then you also mentioned there's this 6040 plus portfolio because you bring some privates in. So maybe you could explain to us what that 6040 plus portfolio is and then some of the other diversifiers you use there. Yeah. And I'm sure as you guys know, we use 6040 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. And a big part of it, 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, 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, it'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 6040 and go back to a new idea of a 6040 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 in the markets that you've 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, you know, buyer beware and you're going to get crushed with the vultures trying to sell you their illiquid bags. Like, I'm not there. I'm not quite that. Michael. However, I do think that as money pours in to an asset class that was previously restricted, has the illiquidity 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, you know, con 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, you can use private credit because that's all the rage these days, a depending on how you measure it, a one and a half, two trillion. million dollar asset class still significantly smaller, obviously than corporates and treasuries, like, duh. But 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 percent in alternatives, depending if you're a pension or an endowment. And that is something that they see, look, all of them. 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. Actually, 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. 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. in 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. And we do think some are better position 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 shifting correlations happening beneath the surface. How much harder is it to offer the forecasts 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. So 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. And 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 back feed, backfill some of the data. And then the last thing we do around volatility is we de-smooth the data. So we try to. 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. For example, in 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 saying. 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 sharp ratio by about 25%. And then we show variations, you know, 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 seem to reach a fever pitch in December was this idea that U.S. stocks would outperform international just forever and ever. It seemed really difficult to make a fundamental case why international. market 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. But here we are in 2025 for the first nine months of the year.

We have the largest outperformance of international stocks versus U.S. 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, when 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, us 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. And 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, and still the U.S. having the biggest drag from the multiple, about two percentage point annualized drag. Wait, got me. Can we just pause there for a second? Yeah. So you expect the U.S. 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 is the big one. And the market was expensive last year. that 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 1015. 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, but 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. outside of that, if it wasn't for where we're coming from, the U.S. should outperform. We just have a final little normalization that needs to happen here. And I got the numbers here.

I think you have the EFET 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 evaluations? 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. Eventually 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 like this is just a new permanent plateau? I'm taking the 1929 saying here. Is that any, 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, and especially coming through very elevated margins. So I thought I was pulling this up just to give some numbers, like some flavor to this. we like, for this purpose, using last 12 months PEs, the long-term average using last 12 months,

the last 20 years, is a P.E 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 P.E. 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 me in. They're just a little bit elevated right now versus the long-term equilibrium. One of the drivers of, or not one of it, the driver of higher multiples, higher margins are these tech giants that we spend too much time talking about, but, you know,

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, 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, you know, breaking because of reasons that are well understood at this point? How do you think about like future inflation fiscal spending versus AI innovation pulling down prices? Like who how do you think about that tug of war? Yeah. And one of the big things I wanted to make sure to get across is even though for some of these forces there's a lot to worry about, there's actually a lot more to be optimistic about.

And I think it's especially because we also have this whole tech innovation wave that's happening. one of those things is inflation. So some forces pushing inflation upwards, especially economic nationalism and fiscal activism. But there are also some forces pulling inflation lower, like technological innovation. And here it's really, I think, the urgency for businesses, not just to adopt AI, but also automation, right? Because otherwise, if you have more limited immigration, if you have protectionism, your costs are just going to, to go up unless you really lean into the technology even more. And then that way, you know, you don't have to sacrifice your margins and you don't have to increase prices as much. So in terms of magnitude, when I was earlier saying that we increased our forecast for U.S. inflation, it's really 2.5%, which, you know, we're above 3% at this point. So it's still saying that a lot of that inflation fades over time, just a little bit higher than maybe the low inflation of the post-GFC world. And importantly, that there can just be a little bit more uncertainty about inflation.

There might be moments when we're like, where's inflation going? It's heading higher. But actually, that it is not a permanent surge in inflation or it's not sackflation. I'm glad you mentioned these competing forces because it does seem like I'm of the opinion that like nothing is going to stop this train in terms of government. spending money and piling debt on top of debt, it doesn't seem like there's just any impetus for anyone to slow that train down. But then you have AI and the other side of this thing. And if it really is as big and as efficient as people seem to think it's going to make our lives, that's deflationary, right? Potentially because it means it's going to impact the labor market.

So how do you try to weigh these things? And you mentioned earlier the fact that like every year you're trying to update new things. Obviously, AI a few years ago was a very new thing. It took everyone by surprise when JetGPT came out in November 2022. So, like, how do you update your priors when something like that happens? And then you have these two competing forces. Is it too easy to think that they could just cancel each other out and we're right back to normal because you have this one inflationary thing and this one deflationary thing? I think it depends where you're looking.

For real economic growth, we actually think AI and tech wins in the sense of you've got headwinds now coming from nationalism, which means older populations, you're actually even if you go a few years out, projecting a negative contribution from your labor force. But at the same time, we gained even more conviction the past year that there's this huge KAPX buildout related to digital and physical infrastructure around tech, and that there's even faster adoption of it across businesses than we had previously expected. So that ends up being a positive when you think about capital stock growth, so just cap X, as well as productivity on top of that. So you would think, wow, this is really challenging for economic growth.

But if anything, we've been slightly nudging up our economic forecasts here in the U.S. and around the world. A lot of that coming from tech. I also think you would say tech innovation means more of a good thing. if you look at equity returns. It's something that can keep margins elevated. It can help with productivity across sectors. So profitability stays high. Otherwise, our returns would be even higher, just given what we talked about with the valuation standpoint. Where it's a bit more challenging is if you're doing that 60-40 traditional portfolio construction, it's just not going to work because you do have these concerns around inflation. You have a risk premium embedded in there for

for governments and even certain corporations. And so you need to, that whole message of diversifying the diversifiers with a 60, 40 plus. I'm sure you got this question all the time. Are we in a bubble? So we don't think we are in as bubbles defined as things have gotten so exuberant, so beyond the fundamentals that there's, there needs to be a massive correction and reset economically and in the markets. I think in the moment we are seeing a big KAPX build out, but at the moment it is being accompanied by actual free cash flow and overall profitability.

But of course, I think every year we keep doing this, we'll keep monitoring exactly how much KAPX versus return on investment. Have we actually seen any improvement in productivity and margins across sectors? And then the risk is a few years from now we could say, all right, now it's too much. and this is going to be a big reset in terms of the capital build-out, economic growth, the markets. So we might get there. People do tend to extrapolate forward quite a lot and get overly enthusiastic. We just don't think we're there at the moment. So outside of some Black Swan event and some exogenous shock that we can't see coming, what would cause your forecast to be the most wrong here? Like, what would make it so,

okay, we were way off here. We didn't get this right. What would that look like? So I think it's two things. I think there's a risk that we're not being optimistic enough. So we're being very, very conservative in how much we think tech adoption will help productivity and how much it can keep margins elevated. There's a risk that we're really underestimating this. Like other houses, for example, have much higher forecasts for the productivity boost. and the margin boost. So I think that's one, you know, maybe 6.7% for large-cap U.S. equities is just not too low, too low ball. Then in terms of the downside, I think where we might be wrong, frankly, is much more around the risk premium. So we're expecting, let's say, a three-month

10-year yield curve. Right now it's flat, totally abnormal. We think the normal state would be something like 120 basis points. But really pre-GFC, you got to as high as 160, 180. So maybe we're being too conservative in how much the premium needs to go into your long-term bonds to compensate people for all of this fiscal activism, inflation uncertainty, nationalism. And so I worried that maybe we're just low-balling, let's say, long-end yields. But we try to account for that when it comes to this idea of inflation volatility, rates volatility, and unstable correlations. And that's where this whole discussion is happening around other diversifiers. So this report with the long-term expected returns, how long are you looking out?

It's supposed to be on average, 10, 15 years out, like a whole business cycle. If there was one thing, which is an unfair question, but I have the microphone and I'm going to ask it anyway, if there was one thing that you got to peer into the future and have this piece of information that would make you feel more confident in nailing these return estimates, what would it be? That is such a good question. I think it's honestly what we end up doing with all of this tech capax. I mentioned we could be low-balling it, and actually it's a lot more productive and amazing. But of course, it equally could all just end up being a bust, and actually we use it to, you know, send cool memes to each other or create different types of social media, and this is all kind of a misallocation of capital that we're doing. So if I could look out five years, ten years, I would want to know what ended up happening with productivity growth. what ended up happening with actually all that return on that investment? That's happening both

in public markets, private markets, governments, corporates, because we're certainly spending heck a lot of capital and manpower on it, and it's going to keep increasing for another few years. Tell me Envidia's market cap in 10 years, and I'll tell you what the stock market is that. But actually, that's interesting because we do think 10 years back, right? you know, six of the top 10 companies weren't there. So maybe what are, what are some of the, you know, companies in someone's basement that are being created that might end up on that top 10? But that is a good thought exercise because if Nvidia in 10 years, let's say where it was

today, it's $4 trillion. That can mean a whole host of things. It can mean that, uh-oh, it's gone nowhere nominally for 10 years that that can't be good. Or it can mean, hey, it's held its market cap, high expectation. but there's three other companies that it now competes with that are also a $3 trillion market caps. So that's why we play the game. That's right.

And that's the feature, right? Having competitive markets, everyone's going to try to get at your big moat and try to compete with you. And then ultimately, today's winners are not tomorrow's winners. And you have to constantly keep changing your portfolio. So you mentioned the moat thing. And it seems like the U.S. almost has a moat around the rest of the world. in terms of the stock market.

And we've gone from, I think the number was 40% or so of world market cap after the GFC to now 65, maybe 70%. The U.S. is just kind of swallowing the rest of the world. It seems like other countries are finally trying to get their act together and make their companies more shareholder friendly. And maybe a lot of the investors in these countries too have decided I need to be more invested in the stock market. Is it going to, is the U.S., the fact that it's so dominant,

is that going to pull other countries back into this thing and make them be more competitive? Because you see all these reports about how, I don't know, I think the one last week was there's the 25 biggest companies in the world and there's like, there's zero from Europe there or something. Like, will that cause meaningful change in these countries to help them compete more? That's such a good question. When we're doing the equity building blocks, so we're thinking about revenues, we're thinking about margins, we're thinking about valuations. but then we also have to think about what's happening with share issuance and buybacks. And for the U.S., we know we have a buyback culture and buybacks having adding three percentage points over time, just buybacks alone, and then we haven't had that much share issuance recently.

So it's been a really important contributor to U.S. equity returns. barely any contribution historically from other developed. And then you had shared dilution in certain emerging markets like China, right, which meant that revenues didn't always translate to the bottom line one for one. And I think if you wanted one thing to get excited about international markets structurally, it's really that they have discovered the secret sauce of buybacks and of focusing on shareholders. So at the moment, if you look at Europe, the US, same buyback yield. If you look at Japan making, that's where you're seeing the biggest growth in buybacks. That's stretching across Asia. Now Korea as well, China as well. So you're

starting to get much more of a focus on shareholders. And that's something that ultimately does drive better long-term returns. I think the second big thing to get excited about, if you just besides what's happening in the equity market, really is Europe this year. You know, we thought Europe was, last year we thought Europe was abandoning fiscal austerity, doing more fiscal spending. But that's just gone on turbo charge this year with Germany joining the party. So Europe deciding that, you know, frugality at the expense of investing in itself wasn't really a good long-term trade. and so we are more optimistic about European CAP-X and productivity after this big announcement in Germany and all of this focus on defense and infrastructure.

So that's another big game changer. Okay, Gabby Santos, that was excellent. We'll come back in 10, 15 years, and we'll give you a scorecard, see what you were. Sounds good. Thank you for the time. Thank you, guys. Thanks so much. Okay, thanks again to Gabby.

Michael and I had to basically sign an NDA and sign over our family by looking at this report before anyone else could see it. But now it's available to everyone so you can go to JPMorgan.com slash LTCMA 26 or just click the link in our show notes and that'll take you to their report. Email us, Animal Spirits at the Compoundews.com.