CONTRIBUTORS
Max Gokhman, CFA
Deputy 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
Preview
In this month’s Allocation Views, we remain positive on risk assets moving into November, as the central tenets of our bullish investment thesis remain in place, despite a variety of factors that threaten to destabilize our view.
Questions around the shape of economic growth have combined with recent US-China trade tensions to challenge our conviction, but these concerns do not outweigh solid macro and corporate fundamentals, in our opinion.
As a result, we adopt a tactically bullish approach across our portfolios, staying risk-on while keeping a close eye on macro and market developments.
Macro data aside, the most convincing argument for our bullish conviction is the ongoing strength of corporate fundamentals, supported by encouraging third-quarter (Q3) earnings results.
From a cross-asset perspective, we have balanced this stance by maintaining our pessimism toward fixed income. We also retain optimism toward commodities, noting that gold may act as a useful inflation hedge.
Macro themes
A resilient growth story
- Leading economic indicators remain resilient, driven by strong services growth.
- Improving sentiment and clarity around tariffs have supported earnings growth and guidance, evidenced by positive Q3 reporting.
- The US economy has proven robust, but we continue to monitor labor-market dynamics for further signs of weakness. US and China trade tensions are also a factor.
Balanced inflation outlook
- Inflation remains above central bank targets in most developed economies. We expect inflation to remain tricky through the end of this year, influenced by tariffs.
- US companies are currently absorbing tariff-induced inflation pressures by tightening margins. An additional material impact on core goods inflation is likely.
- However, services inflation has moderated, helped by lower housing costs, and should offset pressures elsewhere.
Policy leans supportive
- We expect the US Federal Reserve (Fed) to continue to cut interest rates, but we think longer-term expectations for cuts are lofty relative to resilient growth and a balanced inflation outlook.
- Fiscal policy in major economies is becoming an increasingly influential driver of asset prices, notably the US tax bill and stimulus measures in Japan and Germany.
- Despite perceived political influence, we believe the Fed will maintain an objective approach to monetary policy. In Japan, weak growth and political dynamics may hinder policy tightening.
Portfolio positioning themes
Responsibly bullish
- Several major central banks are currently easing into strengthening economies, offering a tailwind to risk assets.
- Equity market momentum is supported by positive earnings revisions and guidance, which outweigh emergent market and political risks, in our view.
- Despite the recent rally in equities, sentiment appears surprisingly neutral. Positioning also remains restrained, leaving room to add exposure.
Diversified equity risk
- We retain our optimistic view of US large-cap stocks, relative to small-cap names. Robust earnings and a supportive macro backdrop guide our thinking.
- We upgrade our view on Japanese equities to neutral, helped by corporate reforms and a repatriation of domestic assets. We downgrade UK equities, influenced by a weak macro backdrop and fiscal tightening.
- We retain a neutral view on Chinese equities, as a technology rally and positive artificial intelligence (AI) trends fuel markets. Sustained retail activity is also a factor.
Underweight government bonds
- We believe longer-term market expectations for Fed policy easing are optimistic. This maintains upward pressure on yields, curtailing our preference for US duration.
- Concerns around fiscal sustainability have driven higher term premia in US Treasuries, increasing the possibility of a supply-demand imbalance.
- Within fixed income, we prefer UK Gilts and Canadian government bonds, amid weak labor markets. We remain underweight Japanese government bonds.
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.
WF: 7394312