CONTRIBUTORS
Wylie Tollette, CFA
Chief Investment Officer,
Franklin Templeton Investment Solutions
Tom Nelson, CFA, CAIA
Head of Market Strategy
Franklin Templeton Investment Solutions
Miles Sampson, CFA
Head of Asset Allocation Research,
Franklin Templeton Investment Solutions
Laurence Linklater
Senior Research Analyst, Franklin Templeton Investment Solutions
Preview
Despite a constructive growth outlook, global equity markets remain in a fragile state. Even with an ongoing disinflationary process and likely rate cuts, rising volatility suggests this is not the time to take aggressive positions in portfolios. Although we believe global stocks still have greater performance potential than global bonds, we maintain the neutral asset allocation stance.
In this month’s Allocation Views, we see persistent divergences in monetary policy and reflect this in our preferences among high-quality bonds. Across asset classes and sectors, we see markets fully discounting the good news that is needed to justify elevated valuations presenting us with a “tricky” investment environment.
Macro themes driving our views
Growth is constructive
- Leading economic indicators suggest continued global growth.
- Recession risks have passed for some developed economies and are low especially for the United States.
- Despite stabilization, growth levels remain at or below trend.
Inflation risks are more balanced
- Significant progress has been made, although it has been bumpy, and inflation is still above targeted levels.
- Elevated services inflation is expected to moderate more slowly due to tight labor markets.
- Core goods inflation has already normalized, but freight cost rises may offset this.
Divergent policy cycles
- More central banks are likely to start cutting rates soon, but with a greater divergence of outcomes likely.
- Inflation progress allows policymakers leeway to balance growth and inflation objectives.
- Central banks remain cautious and will seek data that confirms disinflation before acting.
Portfolio positioning themes
Balance of risks across assets
- A constructive macro environment is typically associated with strong markets, which would support a tilt toward riskier assets.
- However, the level of premium discounted in risky assets remains elevated, and extended sentiment leads to fragile equity markets.
- Policy changes may offset growth and inflation surprises, and the collective mix is more balanced.
A changing equity landscape
- Diminished conviction on the growth outlook for Europe ex UK stocks sees us trim our optimism toward this region.
- The emerging markets remain our preferred region as they are geared to an improving global economy.
- We are marginally less cautious over UK equities but continue to find Canada and Pacific ex Japan less appealing on valuation grounds.
- China remains the most volatile equity market, but policy is more supportive.
Attractive yields for bonds
- Lower yields more recently diminish the return potential from global bonds, causing us to reduce our longer-duration preference in government bonds.
- Easing cycles are likely to begin this year for Western economies, and we find market expectations to be fair.
- Sustained growth supports some optimism toward riskier assets such as high-yield corporate bonds, which we now prefer over bank loans.
- We see value in elevated levels of real yields balanced by continued volatility.
WHAT ARE THE RISKS?
All investments involve risks, including possible loss of principal.
Equity securities are subject to price fluctuation and possible loss of principal.
Fixed income securities involve interest rate, credit, inflation and reinvestment risks, and possible loss of principal. As interest rates rise, the value of fixed income securities falls. Changes in the credit rating of a bond, or in the credit rating or financial strength of a bond’s issuer, insurer or guarantor, may affect the bond’s value. Low-rated, high-yield bonds are subject to greater price volatility, illiquidity and possibility of default.
The allocation of assets among different strategies, asset classes and investments may not prove beneficial or produce the desired results. To the extent a strategy invests in companies in a specific country or region, it may experience greater volatility than a strategy that is more broadly diversified geographically.
Commodity-related investments are subject to additional risks such as commodity index volatility, investor speculation, interest rates, weather, tax and regulatory developments.
International investments are subject to special risks, including currency fluctuations and social, economic and political uncertainties, which could increase volatility. These risks are magnified in emerging markets. The government’s participation in the economy is still high and, therefore, investments in China will be subject to larger regulatory risk levels compared to many other countries.
Investing in privately held companies presents certain challenges and involves incremental risks as opposed to investments in public companies, such as dealing with the lack of available information about these companies as well as their general lack of liquidity.
Active management does not ensure gains or protect against market declines. Diversification does not guarantee a profit or protect against a loss.