Here's the lose-lose situation facing global stock markets

The days of double-digit returns are over.

Lisa Shalett, head of investment/portfolio strategies for Morgan Stanley Wealth Management, said at a press briefing on Tuesday that since the end of the financial crisis, investors have enjoyed healthy returns on stocks and bonds, partly because of the Federal Reserve.

But that’s about to change.

Shalett said:

“Over the last six and a half years, the S&P 500 has compounded roughly 15%, at the same time that the US bond market has compounded at 9% … So if you had a balanced portfolio of stocks and bonds, you experienced superior returns, and that portfolio had double-digit returns.

Our outlook is that that balanced portfolio that delivered those double digit returns probably over the next five to seven years is going to return something a lot closer to four to six per cent.

The Federal Reserve’s bond buying program, known as quantitative easing, together with low interest rates, made it easy for corporations to borrow money and encouraged investors seeking higher returns to invest in riskier assets like stocks.

Now that the stimulus is gone and the Fed is in a “tightening bias” — implying that even if the Fed isn’t raising rates it isn’t making policy any more friendly for businesses — asset prices could begin to reflect a value that is unsupported by monetary policy.

On Thursday, Fed chair Janet Yellen reiterated that the Federal Open Market Committee is willing to raise interest rates this year as long as the economy does not present any major surprises.

Fredgraph (1)FREDIt’s still a bull market, but it’s slowing down.

Several other strategists have also been warning that big investment returns on average soon dwindle, and these comments from Morgan Stanley are adding to the chorus.

Shalett is not making a call that the long term bull market in US stocks is over, just that returns won’t be what they have been.

Going forward, Shalett said one of the challenges Morgan Stanley has is convincing clients to ‘globalize their portfolios.’

Shalett is advising clients, many of whom are US-based and with a “US bias,” to venture out of their comfort zones and into markets that can provide better returns in the next few years.

On a ranking of major stock indexes around the world by year-to-date returns for 2015, the S&P 500 is 11th out of 16th. Russia’s Micex is first.

The take away from this ranking, compiled by Deutsche Bank, is that the Fed’s decision to not raise rates in September has left markets “treading water” and given the impression that global growth concerns may worsen in the coming months.

Screen Shot 2015 09 24 at 11.09.13 AMDeutsche BankThe Fed is complicating everything.

Along with “globalizing” portfolios, Shalett advises that it’s now appropriate for so-called passive investors to begin to discriminate between winning and losing stocks.

She said that like a rising tide, QE took asset prices along, and so riding along with a strategy like indexing was a pretty safe bet. Not anymore.

Shalett said that the market sell off in August was the first time in a while that they saw active managers outperform passive managers. During the drop, the median stock corrected about 20%, she said, and so there are many names up for grabs at a cheap price.

But it all ends up at the feet of the Fed.

A Fed on hold brings uncertainty, and signals to investors that the world economy is tanking. But if the rate hike that Shalett and others have forecast comes to fruition, it will formally signal the end of monetary stimulus and takes away the boost that stocks have enjoyed for the past six years.

Overall, it seems like a lose-lose situation.

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