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
Animal spirits continued to drive global markets in February as investors took confidence from US President Donald Trump’s pro-growth rhetoric. However, uncertainty around the implications of US government policy alongside an uptick in geopolitical tensions has subdued risk assets despite a supportive macroeconomic outlook.
Leading indicators of growth and inflation remain positive for equities, in our analysis, highlighting healthy global growth and an ongoing disinflation trend, but the uncertain policy outlook has influenced our thinking in recent weeks, pushing us to take a more considered approach to asset allocation, while tilting toward “risk-on” in our positioning.
Against this background, we hold a preference for US stocks amid improved corporate fundamentals, but a still-uncertain outlook for international markets curtails our overall risk appetite. Within fixed income, we prefer international bonds given a weaker macro environment outside the United States.
Macro themes
Growth remains constructive
- Leading economic indicators suggest positive global growth .
- Growth reflects ongoing strength in the services sector, while manufacturing activity has also begun to improve.
- US trade tariffs are a headwind to global growth as policy uncertainty discourages investment and limits animal spirits.
Inflation risks lessening
- Significant progress has been made, although it has been bumpy, and inflation is still above targeted levels.
- Elevated services inflation is normalizing gradually alongside labor market strength, while core goods inflation remains weak, despite recent volatility.
- Tariffs have raised short-term inflation expectations, but are more likely to cause a one-off rise in prices rather than have a sustained impact.
Divergent policy outcomes
- We expect a greater divergence of policy outcomes as the Fed recalibrates its interest-rate strategy against a strong US economic backdrop.
- Other Western central banks are set to cut rates more quickly, particularly in Europe where growth is weak.
- Fiscal policy in major economies such as the United States, Germany and China is emerging as an influential driver of asset prices.
Portfolio positioning themes
Growth supports risk assets
- The macro environment is constructive, broadly supporting strong markets.
- Global corporate fundamentals appear robust, as earnings continue to strengthen against the healthy macro backdrop.
- Elevated equity valuations, tight credit spreads and fiscal policy uncertainty represent risks to global growth.
Equities: America first
- Strong earnings growth in the United States influences our positive outlook for US equities.
- Uncertain macro conditions diminish the broad appeal of international equities relative to US stocks, despite attractive valuations.
- We retain a pessimistic view on emerging markets ex China, given global manufacturing weakness, a strong US dollar and the potential negative impact of US fiscal policy.
Convergent bond yields
- We hold a preference for global fixed income, amid falling US Treasury yields, remaining long eurozone duration while we monitor the impact of recent fiscal stimulus.
- Market expectations around the depth and duration of some policy easing cycles have retraced to more appropriate levels.
- Relatively healthy financial conditions support optimism toward corporate bonds, with a slight preference for high-yield 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. There are special risks associated with investments in China, Hong Kong and Taiwan, including less liquidity, expropriation, confiscatory taxation, international trade tensions, nationalization, and exchange control regulations and rapid inflation, all of which can negatively impact the fund. Investments in Hong Kong and Taiwan could be adversely affected by its political and economic relationship with China.
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.