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
A healthy market correction in early August reset sentiment and positioning to more neutral levels and stabilized equity markets. However, potential volatility linked to the upcoming US election, alongside seasonality concerns, tempers our enthusiasm and informs our neutral allocation to risk assets.
In this month’s Allocation Views, given the uncertain environment, equity risk premiums remain low in our view, although a cyclical rotation does offer potential investment opportunities. Elsewhere, falling global bond yields influence a reduction in duration across our fixed income portfolio amid diminished returns. Against this background, we choose to “stay in the saddle” from an investment perspective and await better opportunities to add risk.
Macro themes driving our views
Growth remains relatively constructive
- Leading economic indicators suggest positive, albeit slowing, global growth.
- Global growth is stronger in services whereas manufacturing remains sluggish.
- Market volatility is not likely to lead to slower growth by itself, as 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, but higher freight costs may offset this.
Divergent policy cycles
- More central banks are likely to start cutting rates soon, but with a greater divergence of outcomes likely.
- Inflation progress allows policymakers some leeway to balance growth and inflation objectives.
- Central banks remain cautious and will seek data that confirms disinflation before acting.
Portfolio positioning themes
Balance of risks across assets
- A constructive macro environment is typically associated with strong markets, supporting a tilt toward riskier assets.
- Extended sentiment and positioning have moderated, but equity risk premiums remain low, particularly given seasonal uncertainty.
- Policy changes may offset growth and inflation surprises, suggesting the collective mix is more supportive.
A changing equity landscape
- US equity earning growth is rising and breadth is improving.
- Diminished conviction on the growth outlook for Europe ex-UK stocks, but more positive on UK equities due to an improving macro backdrop.
- Emerging markets ex China remain our preferred region, notably Asian economies, amid strong semiconductor demand.
- We continue to find Canada and Pacific ex Japan less appealing due to relatively weak macro and corporate fundamentals.
Less attractive yields for bonds
- Lower yields diminish the return potential from global bonds, influencing a further reduction in our duration preference among government issues.
- Easing cycles are likely to continue for Western economies, although we find market expectations to be excessive in some cases.
- Sustained growth supports some optimism toward riskier assets such as high-yield corporate bonds, which we prefer to investment-grade issues.
- We see value in elevated levels of real yields, balanced by caution around ongoing market volatility.
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.