HONG KONG, December 15, 2022 – Franklin Templeton and two of its specialist investment managers provide their annual outlooks for the global economy and key asset classes. They include insights from the following investment managers:
- Franklin Income Investors delivers flexible, diversified portfolios of equity, fixed income and hybrid securities focused on maximizing income while maintaining prospects for capital appreciation since 1948.
- Franklin Templeton Emerging Markets Equity focuses on investment opportunities in emerging and frontier markets, where we seek to capitalize on the economic growth potential of these regions.
- ClearBridge Investments provides outlooks on global infrastructure. Headquartered in New York with US$145.6 billion in AUM as of September 30, 2022, it is an authentic active global equity manager with a legacy dating back over 50 years.
- Brandywine Global Investment Management provides insights into global currencies. Headquartered in Philadelphia, Brandywine Global looks beyond short-term, conventional thinking to rigorously pursue long-term value. It has US$52 billion in assets under management (AUM) as of September 30, 2022.
Commenting on U.S. market outlook and asset allocation, Ed Perks, Chief Investment Officer, Franklin Income Investors said:
“The investment landscape heading into 2023 is very different to 12 months ago, when there really was no alternative to equities, and investors were locked into a desperate search for yield across all asset classes. The U.S. Federal Reserve’s (Fed’s) singular focus on controlling inflation during 2022 resulted in an aggressive cycle of rate rises, which in turn tightened financial conditions. This led to a sharp rise in yields and spreads on fixed income assets.
A year ago, yields on high-quality credit did not seem attractive to us, prospects for total returns were poor, and bonds were not acting as a diversifier. Today, we believe the same assets offer better total return potential than equities, while the positive correlation with stocks is also breaking down, allowing fixed income to offset equity market volatility.
As a result, we continue to invest with a preference for fixed income, moving closer to a 60/40 split in favor of bonds over equities. Moving forward, what happens with interest rates and inflation in 2023 will drive our allocation decisions. We believe the move higher in rates is likely almost done, but we expect a long pause from the Fed before any pivot. Thus, we will focus our attention on the effect rate hikes have on the economy and inflation. The uncertainty lies in whether the lagged effect of tightening financial conditions and a more challenging growth environment results in a real pullback in fundamentals.
However, our assessment of U.S. Treasuries has also improved as interest rates have risen, given they currently offer attractive yields and downside protection should a recession increase equity market volatility. When 10-year Treasury yields were around 2% they were unattractive to us but extending duration to lock in yields at 4% is much more compelling from an income perspective. This means U.S. Treasuries will form a core part of our ongoing strategy into 2023.
We still see opportunities for selective investment in equities to maximize yield and total return while navigating increased volatility. For equities to rally, we believe it would take a favorable trajectory around inflation and economic growth, while earnings would also need to remain relatively robust. We would also want to see the Fed pause rate hikes, move into a position to normalize rates, and get back to a neutral setting. Alternatively, there could be further downside for equities if the economy feels the impact of tightening in 2023 and earnings suffer.
We believe the investment environment during 2023 promises to provide much greater potential for yield and total return than we saw at the turn of 2022. In our analysis, locking in attractive yields through duration is the best way to achieve income goals, while investing in fixed income assets at attractive prices should deliver robust returns if rates fall and spreads narrow due to looser Fed policy. Additionally, we think higher-quality bonds offer significant downside protection should any recession prove deeper than expected. Elsewhere, in our opinion, broad equity exposure remains important should an improvement in economic sentiment trigger an equity market rally.”
Commenting on emerging markets, Manraj Sekhon, Head, Templeton Global Investments said:
“With the peak in inflation behind us, investors can focus on the implications of a change in the pace of U.S. Federal Reserve rate hikes. These include a weaker U.S. dollar and a reduction in the equity risk premium, both of which are positive for EM. The possibility of a weaker U.S. dollar in 2023 is likely to be accompanied by a recovery in EM fund flows, as investors turn to higher growth markets.
China’s inflection point began with the easing of access to credit for the real estate sector in October. This was followed by a significant re-set in US-China relations at the G20 meeting in Bali between President Xi Jinping and President Joe Biden in November, which has materially lowered the tension between the two countries. The final catalyst is a shift in China’s stance towards managing COVID-19, which followed the successful conclusion to the 20th National Congress.
The leadership in China has belatedly recognized that the bigger risk it faces is no longer COVID-19, but the growth imperative. Therefore, it is making a major pivot in its priorities—moving away from trying to suppress COVID-19, to a policy of living with the virus. Party leaders are now refocusing their efforts on boosting growth and consumer confidence. This transition is critical given poor economic data and weak consumer confidence which culminated in the recent unrest over the uneven application of its Zero-COVID policies.
China’s exit from its virus suppression policies will not be linear and we should expect some reversals. A rise in fatalities and strains on its hospital system are amongst the biggest risks it will face. This is similar to what was witnessed in other regions when they exited lockdowns. For markets, the pivot is the most important development. Investors are likely to look through policy reversals to the real economic impact of reopening. The performance of other markets post-reopening provides a template for investors.
Looking ahead, we expect 2023 to be favorable to EMs, reflecting their economic resilience, and robust domestic demand. China is likely to be a leader with 15% estimated growth[1] and, we expect a release of pent-up demand as it pivots away from its Zero-COVID strategy to one focused on growth. A pickup in earnings revisions in EMs would act as a confirmation of better times ahead for earnings and, in turn, equity markets.”
Commenting on global infrastructure, Charles Hamieh, Shane Hurst and Nick Langley, Portfolio Managers, ClearBridge Investments said:
“From no growth in 2020 to rapid growth in 2021 to slow growth in 2022, we look at 2023 with a base case of recessions in the U.S., Europe, and the U.K. The impact on infrastructure, though, should be muted, particularly for our regulated assets, where the companies generate their cash flows, earnings and dividends from their underlying asset bases, as we expect those asset bases to increase over the next several years. As a result, infrastructure earnings look better protected compared to global equities.
On top of its relative appeal versus equities, infrastructure should benefit from several macro drivers in 2023 — and beyond. First, energy security is driving policy right now, and a significant amount of infrastructure will need to be built to attain energy security. High gas prices and supply constraints brought on by the Russia/Ukraine war have highlighted the importance of energy security and energy investment. This is supportive of energy infrastructure, particularly in Europe, where additional capacity is needed to supplant Russian oil and gas supply, and in the U.S., where new basins are starting up, in part to meet fresh demand from Europe.
In transport, changing trade routes and adjustments to supply chains to bring production closer to home, either through reshoring or near-shoring, are driving demand for new transport infrastructure. Airports are still struggling to return to pre-pandemic passenger levels, which will likely be interrupted by a global recession in 2023, as well as changes in long-term trends like business travel. Communications infrastructure continues to roll out 5G, develop 6G technology and work to reduce network latency, driving significant investments in wireless tower businesses, generally undertaken under long-term inflation-linked contracts. Although, in the short term, higher interest costs are hitting the bottom line.
In terms of fiscal policy, the U.S. Inflation Reduction Act (IRA), signed into law in August 2022, is the most significant climate legislation in U.S. history. We believe it will be industry transformative for utilities and renewables, in particular. The growing need for electrification — more electric vehicle (EV) charging infrastructure, more residential and small commercial rooftop solar — will require new substations, new transformers and upgraded wires along distribution networks. We already see its impact in the 2023 capital expenditure plans of utilities, together with the forward-order books of companies involved in the energy transition, such as renewable, storage and components suppliers, increasing their growth profile.
One major macro takeaway from the IRA: there is no reason to build anything other than renewables from now on. Much of this is due to tax credits. Production tax credits for solar/wind are available until 2032 or until a 75% reduction in greenhouse gases is achieved (based off 2022 numbers). Either way, this is expected to be a tailwind for investment for well over a decade.
Secular growth drivers for infrastructure should be on full display in 2023. President Biden wants to reduce emissions in the U.S. by 50% by 2030, with roughly half of U.S. power coming from solar plants by 2050. It will require nearly US$320 billion to be invested in electricity transmission infrastructure by 2030 to meet net zero by 2050. The dire need for infrastructure spending underpins growth for the next decade and beyond, and the first steps for meeting these long-term goals are being taken now.”
Commenting on global currencies, Anujeet Sareen, Portfolio Manager at Brandywine Global said:
“After experiencing an historically strong year of appreciation, the U.S. dollar now appears overvalued against a broad basket of currencies, and macroeconomic fundamentals are poised to deteriorate in 2023. The primary drivers of the dollar in 2022 were relative growth outperformance and relative monetary tightening. Although U.S. real growth decelerated in 2022, the substantial growth shocks in Europe, driven by the Ukraine war and energy shock, and in China, resulting from its restrictive zero-COVID policy and property market crisis, led to relative U.S. economic outperformance. In parallel, the Fed raised interest rates by 400 basis points (bps), more than nearly all other major central banks.
Relative monetary policy is also likely to move in parallel with the shift in relative growth. The Fed is likely approaching peak policy rates near 5%, but the European Central Bank, given that its policy tightening cycle began later, may still raise interest rates further in 2023. European inflation is likely to slow somewhat later, and fiscal policy is more supportive of growth in Europe than the U.S. This relative shift in monetary policy is constructive for the euro, all things equal.
In Japan, monetary policy also is poised to begin tightening in 2023. Governor Kuroda, one of the principal architects of Japan’s aggressive reflationary monetary policies, is set to step down in early April. While his successor has not yet been determined, the recent acceleration in Japanese inflation, in contrast with the deceleration in U.S. inflation, has increased the probability of a shift tighter in Japanese monetary policy, which would be constructive for the yen.
Overall, the powerful rally in the dollar in 2022 was driven by an alignment of factors that will not persist in 2023. The greenback is expensive, and relative growth prospects point to a weaker dollar next year. Relative monetary policy will also tighten more outside the U.S., notably in Europe, and possibly in Japan as well. However, the Fed is unlikely to start easing monetary policy soon, and, hence, the positive carry offered by the U.S. dollar will offer some support to the greenback. Balance sheet contraction will further diminish the supply of dollars, also providing support to the currency. In conclusion, the dollar has likely started a peaking process. However, a sustained decline in the dollar will ultimately require the Fed lowering interest rates, the end of quantitative tightening and some expectation of improvement for the global economy, notably outside the U.S.”
About Franklin Templeton
Franklin Resources, Inc. [NYSE:BEN] is a global investment management organization with subsidiaries operating as Franklin Templeton and serving clients in over 155 countries. Franklin Templeton’s mission is to help clients achieve better outcomes through investment management expertise, wealth management and technology solutions. Through its specialist investment managers, the company offers specialization on a global scale, bringing extensive capabilities in fixed income, equity, alternatives and multi-asset solutions. With offices in more than 30 countries and approximately 1,300 investment professionals, the California-based company has over 75 years of investment experience and approximately US$1.4 trillion in assets under management as of November 30, 2022. For more information, please visit franklintempleton.com.hk and follow us on LinkedIn, Twitter and Facebook.
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[1] Source: Bloomberg, November 30, 2022. There is no assurance that any estimate, forecast or projection will be realized.