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
Interest-rate cuts from the US Federal Reserve (Fed) are typically supportive from risk assets in an environment of constructive macro fundamentals. However, elevated equity valuations and uncertainty around near-term forecasts curtail our optimism somewhat. As a result, we retain our neutral allocation stance into October, as we wait for more compelling opportunities to add risk.
In this month’s Allocation Views, deteriorating corporate earnings growth expectations lead us to reduce US equity holdings, adding back to economies with brighter growth prospects, while weak economic growth impacts our view on Japan. Elsewhere, stimulus bolsters our position on China, while lower yields diminish the return potential from US Treasuries, in our view, influencing a preference for other developed market government bonds.
Macro themes driving our views
Growth remains relatively constructive
- Leading economic indicators suggest positive, albeit slowing, global growth.
- Global growth reflects strength in the services sector, but manufacturing remains sluggish.
- Labor-market dynamics remain key across regions.
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 normalizing alongside labor markets.
- Core goods inflation has already normalized.
Divergent policy outcomes
- Western central banks have started cutting rates.
- Globally, we expect policy easing to influence a greater divergence of outcomes.
- Inflation progress allows policymakers leeway to implement easier monetary policy, offering greater potential downside protection for markets.
Portfolio positioning themes
Balance of risks across assets
- A constructive macro environment is typically associated with strong markets.
- Extended sentiment has moderated, but equity risk premiums remain low, particularly given seasonal uncertainty.
- Policy changes may help to offset growth and inflation surprises and moderate recession risks.
A changing equity landscape
- Weaker earnings growth momentum in the United States influences a reallocation across developed market equities.
- Recent stimulus measures inform our neutral view on China, while emerging markets (EMs) ex-China remain a preferred cyclical region.
- UK equities offer a defensive complement to cyclical EM exposure, while we downgrade Japan amid weak macro conditions.
Less attractive yields for bonds
- Lower yields diminish the return potential from global fixed income, supporting our neutral duration preference in government bonds.
- Market expectations around the depth and duration of some policy easing cycles are excessive, in our view.
- Relatively healthy financial conditions support optimism toward high-yield corporate bonds, which we prefer over investment-grade issues.
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.