CONTRIBUTORS
Christy Tan
Senior investment Strategist
Franklin Templeton Institute
Introduction
In the first half of 2023, investors faced aggressive US Federal Reserve (Fed) monetary policy tightening, two of the largest bank failures in US history, a near-default by the US federal government, and universal predictions of US and global recessions. With all this noise, how do we isolate the key indicators moving the economy?
The Franklin Templeton Institute US Fixed Income Navigator (FIN) specifically addresses this challenge. The FIN can be seen as a compass that helps investors navigate through complex fixed income markets. The engine of the program is the quantitative model that combines macro, fundamental and technical indicators into one equally weighted diffusion index which is used to spot divergence. This divergence can signal strength or weakness that is more visible when you look at a multitude of indicators.
We use 20+ components that are grouped into five buckets “LYVFE” (pronounced as “Life”) which stands for Liquidity, Yield Curve, Valuation, Financials, and Economic Momentum. A distinct set of factors drives each of the building blocks, and yet, they are all interdependent. They must be analyzed in conjunction with each other. We plan to share more details on each component in future papers. The model reviews bonds relative to their own longterm historical performance. A positive reading means that the model expects bond returns to be greater than the long-term average.
The analysis begins with an assessment of “Liquidity,” which is understood as the availability and accessibility of money for both financial institutions and non-financial private sector. The liquidity pillar affects all the remaining building blocks. Liquidity conditions in the financial sector determine investors’ appetite to take risk, while the availability of money for the real economy drives the spending and investment decisions that both consumers and businesses make. The “Yield Curve” and “Valuation” pillars are composed of fast-moving market inputs, reveal market expectations and sentiment. They tend to impact bond pricing directly.
The “Financials” and “Economic Momentum” pillars, composed of slower-moving macro and fundamental inputs, frame the bigger picture and help identify where we are in the business cycle and where we are heading.
Here are our latest views based on analysis of second quarter data, with a special emphasis on the second building block of our model which is the “Y”—Yield Curve.
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. Low-rated, high-yield bonds are subject to greater price volatility, illiquidity and possibility of default.