Farrelly's Economic Scenarios:
Navigating the Full Probability Landscape
Beyond the Expected: Understanding the Full Spectrum of Market Outcomes for Smarter Financial Planning.
Source: Farrelly's Dynamic Asset Allocation Handbook - June 2025 (Page 41)
Have you ever considered the underlying assumptions that guide your financial advisor's investment recommendations? How many different economic scenarios were truly considered, and what likelihood is assigned to each? Understanding the potential earnings of various portfolio components under different future conditions is a crucial aspect of robust financial planning.
The infographic below illustrates the current outlook for a range of scenarios as modeled by the Farrelly's Investment Process. Each advisor and their licensee will have their preferred method for presenting this vital information, but its inclusion is fundamental to a comprehensive approach to managing your wealth.
Base Case - Muddle Through
The developed world grows slowly, largely due to weak demographics. Corporate profits grow much the same as usual, inflation and interest rates remain low. Emerging markets continue strong economic growth. Australia grows somewhat slower than usual. The resources boom ends. Sometime over the next decade, most economies experience a sharp V-shaped recession.
Back to the Old Normal
We return to the great moderation - Cash rates back to 2% to 3% and inflation around 2.5%, GDP growth at around 3%pa growth rates and PE ratios back to at 16 to 18 times earnings.
Boom
Governments reject calls for austerity and engage in expansionary spending. Confidence returns and economic growth picks up worldwide. Budgets come back into balance as taxes increase with earnings. A brief burst of higher inflation is calmed by moderate monetary and fiscal fightening. Emerging market growth accelerates. profits grow rapidly, commodity prices recover.
Recession
Most of the developed world, including Australia, experiences little or no growth for the decade. Inflation and interest rates are low, and profit growth is negative as companies struggle to maintain profit margins. PEs fall to low levels.
Western Recession - Not Australia
The world divides into two groups: those struggling under high government debt; and, those with low debt and deficits. For the developed world, the scenario is as per the Recession scenario above. For Australia and the emerging markets, it looks like the Base case/Muddle through scenario.
Wither Australia
The rest of the world follows the Base case/Muddle through scenario while Australia experiences little or no growth, falling EPS, and low PE ratios.
Depression
The roadmap is the Great Depression of the 1930s. Real economic growth is negative, interest rates very low, earnings collapse, and PE ratios fall. This scenario strikes all economies including emerging markets.
Stagflation
The benchmark is the 1970s – high inflation, very high interest rates, sluggish growth and low EPS growth. PE ratios are also low. This condition hits the majority of the developed world.
Hyper-inflation
Much of the world experiences hyperinflation such as was seen in Weimar Germany in the 1930s. Property maintains value but equities and paper-based assets are essentially wiped out in real terms.
Why Farrelly's Looks Beyond the Obvious:
Your Advantage in Volatile Markets
Many standard long-term portfolio benchmarks and Strategic Asset Allocation (SAA) approaches from major investment players often present return ranges without explicitly defining them with strict statistical confidence levels (e.g., 90% or 95% likelihood). Instead, they typically use terms like "dispersion bands," "plausible ranges," or "confidence bands" that represent a distribution of potential outcomes based on complex models and expert judgment.
This approach, while common, can inadvertently understate the impact of less probable but impactful "tail risk" events, particularly when markets are 'Fully Priced' or 'Overpriced' and could face prolonged periods of underperformance.
This is where the Farrelly's system, and its use of Dynamic Asset Allocation (DAA) methodology, stands apart. When planners use a system like this, they will rigorously integrate a comprehensive range of economic scenarios, explicitly assigning probabilities to each outcome (as seen in the infographic above). This includes detailed modeling of less probable but impactful 'tail risk' events like depressions or severe stagflation.
By anticipating and modeling these wider possibilities, even those with probabilities as low as <1.0%, the hope is to build more resilient portfolios designed to navigate the full spectrum of market conditions, not just the expected ones.
No matter who your Advisor is, a comprehensive analysis ensures their advice is nuanced and robust, preparing you for all eventualities.
Legend
75% Probability Range: The stated range of returns indicates that 75% of the Monte Carlo simulations for that scenario produced returns within this range.
(All returns are 10-year nominal unless otherwise specified).
Further Reading: Explore Capital Market Assumptions from Other Leading Firms
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BlackRock: Their Capital Market Assumptions (CMAs) discuss "Central Tendency" and "Dispersion Bands" representing the distribution of potential outcomes.
BlackRock Capital Market Assumptions - Institutional -
Vanguard: Their Vanguard Capital Markets Model (VCMM) explicitly states that their projected return ranges are NOT traditional confidence intervals, but capture the middle 50% (interquartile range - IQR) of their simulated outcomes.
Vanguard Economic and Market Outlook (Australia) -
JPMorgan Asset Management: Provides a "Base Case" and "Confidence Bands" but clarifies these should not be interpreted as precise statistical confidence intervals due to their blend of quantitative and qualitative inputs.
J.P. Morgan Long-Term Capital Market Assumptions -
Mercer: Uses a "Best Estimate" and a "Range" that reflects both inherent forecasting uncertainty and the potential variability of actual returns.
Mercer's 2024 Table of Investment Returns (NZ) -
Lonsec: While less publicly detailed on specific CMA methodologies, Lonsec's approach emphasizes qualitative assessment of risk and return trade-offs and scenario testing within their SAA recommendations.
Lonsec Official Website (Specific CMA methodology documents are often proprietary or for professional subscribers) -
State Street Global Advisors (SSGA): Generally aligns with central estimates and illustrative ranges, focusing on broad market outlooks and thematic insights rather than explicit statistical confidence levels in public documents.
State Street Global Advisors Insights (Look for their broader outlooks for CMA context)