FRANKLIN TEMPLETON THINKSTM ALLOCATION VIEWS
Allocation Views
Perspective from Franklin Templeton Multi-Asset Solutions
JANUARY 2019
Constructive longer-term outlook…
still tempered by shorter-term concerns
Last month we published our longer-term capital market expectations. This came amid increased market volatility, divergent economic performance, and looming trade wars. We asked if we should take solace in a constructive longer-term outlook?
We highlighted shorter-term concerns that tempered our enthusiasm for stocks. Specifically, a return to long-run levels of market volatility, rather than the muted levels seen for much of the past ten years, which indicated a new volatility regime. As we reviewed our conviction levels, we tilted towards a more cautious outlook.
Looking at our score-card of global growth indicators, we continue to see a less positive outlook than was the case in the early part of 2018. A range of indicators are slowing, not just global trade growth. However, our key measures of the health of the US business cycle remain supportive of a continued period of sustained growth.
2018 ended with a bang. Some investors have become concerned that a pause in growth is close enough at hand to justify reducing risk, even if just on a tactical basis. The level of US Treasury yields has fallen sharply which could imply a less optimistic outlook. A year that has already proved challenging for many investors concluded with market concerns for the sustainability of the global economic expansion.
We believe our cautious approach has been justified. However, many concerns remain unchanged or unresolved. As we revisit our convictions, the challenges facing investors persist.
Constructive longer-term outlook…
still tempered by shorter-term concerns
Subdued inflation in recent years has been explained in terms of globalization. Even as the fears of deflation have faded, this trend has continued to prevent core traded goods prices from rising. US core inflation has remained stable, even as food, energy and service prices moved higher (See Exhibit A). The impact has been global and has persisted throughout this business cycle. As a result, our central assumption is that inflation pressures will remain modest.
However, the sharp decline in the price of oil, with Brent Crude down more than 40% from its recent peak in early October (See Exhibit B on the next page), had lessened the energy-induced inflationary pressure for now. As one of the key drivers of inflation expectations, global bond yields have fallen partly as a result of this change. We have changed the balance of our convictions among fixed income assets, modestly lowering duration overall, mainly by reversing a positive conviction on eurozone bonds.
CORE INFLATION REMAINS SUBDUED
Exhibit A: US Consumer Price Index (CPI) vs. US Core CPI, YOY Change
October 31, 2008 to November 30, 2018
Source: Franklin Templeton Capital Market Insights Group, FactSet, Bureau of Labor Statistics. Important data provider notices and terms available at www.franklintempletondatasources.com.
OIL PRICE DECLINE REDUCES THREAT OF INFLATION
Exhibit B: Brent Crude Oil Price ($ per barrel)
January 3, 2014 to January 3, 2019
Source: Franklin Templeton Capital Market Insights Group, FactSet. Important data provider notices and terms available at www.franklintempletondatasources.com.
Growth divergence remains a concern
Last year, we observed a growing market concern about the desynchronization of global growth, which was reflected in a widening relative performance dispersion between markets. The extent of emerging market underperformance through early October was notable, but not unprecedented (see Exhibit C).
Fears of continued trade conflict have seen largely idiosyncratic concerns in emerging markets broaden out into a more expansive market decline. Political risks are an ever-present concern, but at times of broader uncertainty can act as a driver of investor caution. Indeed, sentiment has been dented more recently. Despite a temporary easing of trade tensions with China, the United States gave up its role as an oasis of relative calm and led global stock markets lower during the close of 2018.
Concerns extended to high yield corporate bonds and other less liquid parts of the credit market. Reflecting this, we lowered our conviction in leveraged loans, but remain constructive given the outlook for the business cycle remains favorable.
A rational desire to expand the “defensible space” within portfolios has seen us increase conviction in US dollar cash and Treasury Bills. However, this pushes against logical calls to avoid becoming a panicked seller as market declines mount. We suggest that a change of mind-set may be required as markets transition from a momentum-driven to a range-trading environment.
The sequencing of further market pain, a potential Fed pause, and likely rebound are uncertain. It will require nimble management to navigate the challenges that 2019 looks set to present.
DIVERGENT EQUITY MARKET PERFORMANCE
Exhibit C: MSCI World vs. MSCI Emerging Markets Performance
January 1, 2004 to December 31, 2018
Source: Franklin Templeton Capital Market Insights Group, MSCI, FactSet. MSCI makes no warranties and shall have no liability with respect to any MSCI data reproduced herein. No further redistribution or use is permitted. This report is not prepared or endorsed by MSCI. Important data provider notices and terms available at www.franklintempletondatasources.com.
Franklin Templeton Thinks: Allocation Views
Our research process monitors a consistent set of objective indicators and screens them to identify signals that help our analysts to make better recommendations. By doing this we aim to filter out the daily noise to reveal the underlying trend.
Our macro-economic research group aims to challenge the consensus forecasts for growth and inflation by digging deeper into the data. Just as important, we aim not to be swayed unduly by topics that are dominating current market debate.
WHAT ARE THE RISKS?
All investments involve risks, including possible loss of principal. The positioning of a specific portfolio may differ from the information presented herein due to various factors, including, but not limited to, allocations from the core portfolio and specific investment objectives, guidelines, strategy and restrictions of a portfolio. There is no assurance any forecast, projection or estimate will be realized. Stock prices fluctuate, sometimes rapidly and dramatically, due to factors affecting individual companies, particular industries or sectors, or general market conditions. Bond prices generally move in the opposite direction of interest rates. Thus, as the prices of bonds in an investment portfolio adjust to a rise in interest rates, the value of the portfolio may decline. Special risks are associated with foreign investing, including currency fluctuations, economic instability and political developments. Investments in emerging markets, of which frontier markets are a subset, involve heightened risks related to the same factors, in addition to those associated with these markets’ smaller size, lesser liquidity and lack of established legal, political, business and social frameworks to support securities markets. Because these frameworks are typically even less developed in frontier markets, as well as various factors including the increased potential for extreme price volatility, illiquidity, trade barriers and exchange controls, the risks associated with emerging markets are magnified in frontier markets. Derivatives, including currency management strategies, involve costs and can create economic leverage in a portfolio which may result in significant volatility and cause the portfolio to participate in losses (as well as enable gains) on an amount that exceeds the portfolio’s initial investment. A strategy may not achieve the anticipated benefits, and may realize losses, when a counterparty fails to perform as promised. Currency rates may fluctuate significantly over short periods of time and can reduce returns. Investing in the natural resources sector involves special risks, including increased susceptibility to adverse economic and regulatory developments affecting the sector—prices of such securities can be volatile, particularly over the short term.
IMPORTANT LEGAL INFORMATION
This material is intended to be of general interest only and should not be construed as individual investment advice or a recommendation or solicitation to buy, sell or hold any security or to adopt any investment strategy. It does not constitute legal or tax advice.
The views expressed are those of the investment manager and the comments, opinions and analyses are rendered as at publication date and may change without notice. The information provided in this material is not intended as a complete analysis of every material fact regarding any country, region or market. All investments involve risks, including possible loss of principal.
Data from third party sources may have been used in the preparation of this material and Franklin Templeton Investments (“FTI”) has not independently verified, validated or audited such data. FTI accepts no liability whatsoever for any loss arising from use of this information and reliance upon the comments opinions and analyses in the material is at the sole discretion of the user. Products, services and information may not be available in all jurisdictions and are offered outside the U.S. by other FTI affiliates and/or their distributors as local laws and regulation permits. Please consult your own professional adviser for further information on availability of products and services in your jurisdiction.
Canada
FRANKLIN TEMPLETON THINKSTM ALLOCATION VIEWS
Allocation Views
Perspective from Franklin Templeton Multi-Asset Solutions
JANUARY 2019
Constructive longer-term outlook…
still tempered by shorter-term concerns
Last month we published our longer-term capital market expectations. This came amid increased market volatility, divergent economic performance, and looming trade wars. We asked if we should take solace in a constructive longer-term outlook?
We highlighted shorter-term concerns that tempered our enthusiasm for stocks. Specifically, a return to long-run levels of market volatility, rather than the muted levels seen for much of the past ten years, which indicated a new volatility regime. As we reviewed our conviction levels, we tilted towards a more cautious outlook.
Looking at our score-card of global growth indicators, we continue to see a less positive outlook than was the case in the early part of 2018. A range of indicators are slowing, not just global trade growth. However, our key measures of the health of the US business cycle remain supportive of a continued period of sustained growth.
2018 ended with a bang. Some investors have become concerned that a pause in growth is close enough at hand to justify reducing risk, even if just on a tactical basis. The level of US Treasury yields has fallen sharply which could imply a less optimistic outlook. A year that has already proved challenging for many investors concluded with market concerns for the sustainability of the global economic expansion.
We believe our cautious approach has been justified. However, many concerns remain unchanged or unresolved. As we revisit our convictions, the challenges facing investors persist.
Constructive longer-term outlook…
still tempered by shorter-term concerns
Subdued inflation in recent years has been explained in terms of globalization. Even as the fears of deflation have faded, this trend has continued to prevent core traded goods prices from rising. US core inflation has remained stable, even as food, energy and service prices moved higher (See Exhibit A). The impact has been global and has persisted throughout this business cycle. As a result, our central assumption is that inflation pressures will remain modest.
However, the sharp decline in the price of oil, with Brent Crude down more than 40% from its recent peak in early October (See Exhibit B on the next page), had lessened the energy-induced inflationary pressure for now. As one of the key drivers of inflation expectations, global bond yields have fallen partly as a result of this change. We have changed the balance of our convictions among fixed income assets, modestly lowering duration overall, mainly by reversing a positive conviction on eurozone bonds.
CORE INFLATION REMAINS SUBDUED
Exhibit A: US Consumer Price Index (CPI) vs. US Core CPI, YOY Change
October 31, 2008 to November 30, 2018
Source: Franklin Templeton Capital Market Insights Group, FactSet, Bureau of Labor Statistics. Important data provider notices and terms available at www.franklintempletondatasources.com.
OIL PRICE DECLINE REDUCES THREAT OF INFLATION
Exhibit B: Brent Crude Oil Price ($ per barrel)
January 3, 2014 to January 3, 2019
Source: Franklin Templeton Capital Market Insights Group, FactSet. Important data provider notices and terms available at www.franklintempletondatasources.com.
Growth divergence remains a concern
Last year, we observed a growing market concern about the desynchronization of global growth, which was reflected in a widening relative performance dispersion between markets. The extent of emerging market underperformance through early October was notable, but not unprecedented (see Exhibit C).
Fears of continued trade conflict have seen largely idiosyncratic concerns in emerging markets broaden out into a more expansive market decline. Political risks are an ever-present concern, but at times of broader uncertainty can act as a driver of investor caution. Indeed, sentiment has been dented more recently. Despite a temporary easing of trade tensions with China, the United States gave up its role as an oasis of relative calm and led global stock markets lower during the close of 2018.
Concerns extended to high yield corporate bonds and other less liquid parts of the credit market. Reflecting this, we lowered our conviction in leveraged loans, but remain constructive given the outlook for the business cycle remains favorable.
A rational desire to expand the “defensible space” within portfolios has seen us increase conviction in US dollar cash and Treasury Bills. However, this pushes against logical calls to avoid becoming a panicked seller as market declines mount. We suggest that a change of mind-set may be required as markets transition from a momentum-driven to a range-trading environment.
The sequencing of further market pain, a potential Fed pause, and likely rebound are uncertain. It will require nimble management to navigate the challenges that 2019 looks set to present.
DIVERGENT EQUITY MARKET PERFORMANCE
Exhibit C: MSCI World vs. MSCI Emerging Markets Performance
January 1, 2004 to December 31, 2018
Source: Franklin Templeton Capital Market Insights Group, MSCI, FactSet. MSCI makes no warranties and shall have no liability with respect to any MSCI data reproduced herein. No further redistribution or use is permitted. This report is not prepared or endorsed by MSCI. Important data provider notices and terms available at www.franklintempletondatasources.com.
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Franklin Templeton Thinks: Allocation Views
Our research process monitors a consistent set of objective indicators and screens them to identify signals that help our analysts to make better recommendations. By doing this we aim to filter out the daily noise to reveal the underlying trend.
Our macro-economic research group aims to challenge the consensus forecasts for growth and inflation by digging deeper into the data. Just as important, we aim not to be swayed unduly by topics that are dominating current market debate.
WHAT ARE THE RISKS?
All investments involve risks, including possible loss of principal. The positioning of a specific portfolio may differ from the information presented herein due to various factors, including, but not limited to, allocations from the core portfolio and specific investment objectives, guidelines, strategy and restrictions of a portfolio. There is no assurance any forecast, projection or estimate will be realized. Stock prices fluctuate, sometimes rapidly and dramatically, due to factors affecting individual companies, particular industries or sectors, or general market conditions. Bond prices generally move in the opposite direction of interest rates. Thus, as the prices of bonds in an investment portfolio adjust to a rise in interest rates, the value of the portfolio may decline. Special risks are associated with foreign investing, including currency fluctuations, economic instability and political developments. Investments in emerging markets, of which frontier markets are a subset, involve heightened risks related to the same factors, in addition to those associated with these markets’ smaller size, lesser liquidity and lack of established legal, political, business and social frameworks to support securities markets. Because these frameworks are typically even less developed in frontier markets, as well as various factors including the increased potential for extreme price volatility, illiquidity, trade barriers and exchange controls, the risks associated with emerging markets are magnified in frontier markets. Derivatives, including currency management strategies, involve costs and can create economic leverage in a portfolio which may result in significant volatility and cause the portfolio to participate in losses (as well as enable gains) on an amount that exceeds the portfolio’s initial investment. A strategy may not achieve the anticipated benefits, and may realize losses, when a counterparty fails to perform as promised. Currency rates may fluctuate significantly over short periods of time and can reduce returns. Investing in the natural resources sector involves special risks, including increased susceptibility to adverse economic and regulatory developments affecting the sector—prices of such securities can be volatile, particularly over the short term.
IMPORTANT LEGAL INFORMATION
This material is intended to be of general interest only and should not be construed as individual investment advice or a recommendation or solicitation to buy, sell or hold any security or to adopt any investment strategy. It does not constitute legal or tax advice.
The views expressed are those of the investment manager and the comments, opinions and analyses are rendered as at publication date and may change without notice. The information provided in this material is not intended as a complete analysis of every material fact regarding any country, region or market. All investments involve risks, including possible loss of principal.
Data from third party sources may have been used in the preparation of this material and Franklin Templeton Investments (“FTI”) has not independently verified, validated or audited such data. FTI accepts no liability whatsoever for any loss arising from use of this information and reliance upon the comments opinions and analyses in the material is at the sole discretion of the user. Products, services and information may not be available in all jurisdictions and are offered outside the U.S. by other FTI affiliates and/or their distributors as local laws and regulation permits. Please consult your own professional adviser for further information on availability of products and services in your jurisdiction.