2025 capital market assumptions

Earnings growth: We use expected real GDP growth plus inflation as the proxy for earnings growth, in line with standard practices. For inflation and real earnings growth assumptions, we seek the input of economists on our Capital Strategy Research team and reference a global macro model.

Dividend yield: For the dividend yield component for most equities, we take an average of the prevailing dividend yield and the median historical yield for the corresponding MSCI regional or country index.

Net dilution/accretion: We account for net dilution/accretion to capture the expected gap between GDP growth and EPS growth, and the impact of EPS dilution or accretion. Net dilution is estimated as in Bernstein and Arnott (2003)*, which suggests using the ratio of an index’s market cap to its price level as a simple measure of the net impact of share issuance and buybacks. As markets grow through new issuance, the number of listed shares increases, diluting the ownership of existing shareholders. Hence, high economic growth doesn’t necessarily translate to higher EPS growth, as we have seen in several emerging markets over the last decade.

We combine two approaches in determining our estimates: (1) regression using various productivity measures (the theory being that productivity growth coincides with economic growth and has also empirically been shown to be meaningful to net dilution), and (2) regression to estimate net buyback yield using cash and cash equivalents, long-term debt and tax-rate estimates as the variables, and supplement that with views from our economist team and historical trends.

Valuation: The impact of valuations is computed as the multiple expansion or contraction from current valuation levels to a target valuation. The valuation measure we consider is the cyclically adjusted price-to-earnings ratio (CAPE) of the corresponding MSCI regional or country indexes. This ratio measures the real price in the numerator and the average of real earnings over the last 10 years in the denominator. The target valuation is a blend of mean reversion and “fair value” CAPE. The latter is calculated using a multivariate regression of CAPE to real GDP growth and the 10-year yields. The current CAPE ratio is measured against the target CAPE ratio to determine if a market is over or undervalued.

*Bernstein, W.J. and R.D. Arnott (2003), “Earnings Growth: The Two Percent Dilution,” Financial Analysts Journal, 59:5, 47-55.

Yield to worst: We start with the trailing 12-month yield to worst for the corresponding proxy index (principally Bloomberg and J.P. Morgan indexes) and generally project ending yields in 10 years’ time. Yield to worst is the lowest yield that can be realized by either calling or putting on one of the available call/put dates, or holding a bond to maturity.

The projected ending yields are based on historical spreads over the U.S. intermediate-duration Treasuries index with a view as to whether spreads will be tighter or wider in the future relative to where they are today. Convexity adjustment is applied where prepayment is a large feature of the asset class. The return for each year is calculated based on the prevailing duration of the index and a change in yields, plus any impact from default losses and currencies.

Default losses: The assumptions we use for default losses are based on historical averages and expectations for losses in that asset class.