Morningstar Magazine - August/September 2018 - 25

10-Year Annualized Nominal Return Expectations for U.K. Investors
Valuation-Implied Return in GBP terms

8%
6.1

6.0

6.0
5.2

EM
Europe Stk

United
Russia Stk
Kingdom Stk

Japan Stk

4.3

3.8

3.7

EM Asia Stk EM Debt (LC) Europe
ex-UK Stk

3.6

2.8

EM Debt
(HC)-Hdg

China Stk

2.6

2.0

EM Latin
US Treasury
America Stk -Hdg

1.9

1.6

2
0

Paciﬁc
UK Corporate US Stock
ex-Japan Stk Debt

Source: Morningstar. Data as of 05/31/2018.

Positive sentiment continues to surround the
outlook for U.S. growth, with a booming technology sector and corporate tax rate cuts influencing
demand. This has heightened our cautious
stance, with the asset class now offering negligible
expected returns after inflation, based on
our valuation analysis. While acknowledging the
structural improvement in fundamentals brought
about by the lower corporate tax rate, we
believe that much of the good news relating to the
strengthening U.S. economy is now more than
priced into the market. With U.S. shares now
trading well ahead of our fair value estimates, there
is an elevated risk of a permanent loss of capital.
An exception to this is the U.S. healthcare sector,
which has been plagued by uncertainty given the

Trump administration's attempts to repeal
Obamacare and reform pharmaceutical drug
pricing policy. While delays and a softening
of this agenda have tempered negative sentiment,
resulting in a strong start for the sector in
2018, a valuation opportunity nonetheless remains.
Further, the majority of companies that
make up the U.S. healthcare index, by market
capitalization, such as Johnson & Johnson
JNJ, Pfizer PFE, and Bristol-Myers Squibb BMY,
have wide or narrow moats according to
Morningstar's equity analysts, highlighting the
sustainability of earnings in the sector.
Dan Kemp is chief investment officer, EMEA, for
Morningstar Investment Management Europe. He is a
member of the editorial board of Morningstar magazine.

Volatility in Italian
Assets Hits Bond
Investors Hardest
G REATER EUROP E

Italy

After months of political stalemate, Italian assets
came under pressure in late May as the
Five Star Movement and the League finalized
their agreement to form the first populistled government in the eurozone. The sell-off
accelerated on May 29. Yields on Italian
government bonds soared as markets repriced the

Combined Effect of Climate Change and Soil Erosion
U.S. Grain Yields

1970-2040E

2.00

PROJECTION

Projected Data
2040E Yield
Only of historical productivity advances 1.40
Including diminishing marginal returns
1.17
Including impact of soil erosion
1.06
Including erosion after increased flooding 1.02
Including effect of climate change
0.50
Including 1/3 adaption to climate change 0.68

1.50

-56%

1.00

Historical Data
-38% from 2017

0.50

2017 index averaging corn, wheat, soy, and rice yield is 1.00

1970

1980

1990

2000

2010

What are the consequences of these high
temperatures? Extreme downpours resulting in soil
erosion, floods, droughts, wildfires, and
extreme temperature occurrences are all on the
rise. These climate change events adversely
affect global grain production. In the United
States, the combined effects of climate change
and soil erosion will lead to plummeting
grain yields, as much as 56% from historical
productivity advances, Grantham said.

0.00
2020E

2030E

Source: USDA NASS, Rhodes 2014, Liang et al 2017, GMO. Data as of 04/30/2018.

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Table of Contents for the Digital Edition of Morningstar Magazine - August/September 2018