CONTRIBUTORS
Michael Greenberg, CFA, CAIA
Portfolio Manager,
Franklin Templeton Investment Solutions
There is a famous Warren Buffet saying that says “…only when the tide goes out do you discover who's been swimming naked.” Global central banks have been aggressively raising rates and we might now be seeing who has indeed been swimming naked.
Portfolio exposures
First looking at our portfolios, we have minimal exposure to some of the challenged areas of the market:
As of February 28, 2023.
The focus here will be on the macro implications for the broader economy rather than the micro predictions at the bank-by-bank level.
Banks and the economy
With central banks trying to slow down the economy to combat inflation, the recent banking stresses will even further tighten financial conditions. Even before the recent banking issues surfaced, we had already seen credit conditions begin to tighten. Historically this has been a precursor to wider credit spreads suggesting a weaker economic environment. Even tighter lending standards seem inevitable given recent events.
Loan Standards vs Credit Spreads
As of March 2023.
Source: Fed, Bloomberg, Macrobond. Important data provider notices and terms available at www.franklintempletondatasources.com.
If banks start to reduce lending because they are facing lower deposits, higher funding costs and potential tighter regulation this reduces the flow of capital into the economy. Lower access to capital curtails companies from expanding and feeding economic growth. This can be especially apparent in small businesses, that are extremely important for the broader economy, and are already feeling glum!
NFIB U.S. Small Business Optimism Index
As of February 2023.
Source: NFIB, Macrobond. Important data provider notices and terms available at www.franklintempletondatasources.com.
In some sense this is desired as a means to slow inflation. Slower growth and weaker demand should reduce pricing pressures. The risk of course as is that the slowdown turns into a hard landing and a more severe recession unfolds.
Portfolio positioning
Our view is that the probability of recession has increased which will challenge economic growth and corporate earnings. There are still some positives to consider; higher savings rates, strong labor markets and declining inflation all bode well for the economy. As we balance this all out, we remain convicted in our decision to be more risk-off within portfolios with lower equity weights and higher cash balances.
Within fixed income we are more conservatively position with higher government bond and longer duration positioning. We prefer high quality credit exposures over the riskier parts of the debt market for now.
We will need to continue to be nimble given this is a fast-moving situation. At some point the bad news will be reflected in prices and adjustments to positioning will be necessary.
Comments, opinions, and analyses are for informational purposes only and should not be considered individual investment advice or recommendations to invest in any security or to adopt any investment strategy. Because market and economic conditions are subject to rapid change, comments, opinions and analyses are rendered as of the date of the posting and may change without notice. The material is not intended as a complete analysis of every material fact regarding any country, region, market, industry, investment, or strategy.
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