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
Despite the positive newsflow as of late, much economic uncertainty remains across a medium-term horizon. Leading indicators of US growth have moved into regimes synonymous with negative equity returns, while consumer sentiment and CEO confidence remain weak and inflation expectations have risen.
A new dimension adding further uncertainty to the investment equation is the wide-ranging tax cuts that President Trump hopes will offset any drag on growth from tariffs. This may reduce the US Federal Reserve’s ability to cut interest rates in support of the US economy and expand the fiscal deficit, adding further upward pressure on long-term US Treasury yields.
Against this background, we remain neutral on equities in this month’s Allocation Views, as we assess the impact of ongoing tariff policy. Elsewhere, we favor cash over fixed income, as deficit concerns add uncertainty and erode the attractiveness of US duration.
Macro themes
Softening growth
- Leading economic indicators suggest growth is slowing.
- Forward-looking survey data indicate growth is likely to decelerate further. However, labor market data remains resilient.
- Volatile US tariff policy continues to fuel uncertainty, discouraging investment and depleting “animal spirits” over time.
Uncertain inflation outlook
- Significant progress has been made, although it has been bumpy, and inflation is still above targeted levels.
- Consumer survey data suggest a marked rise in inflation expectations, influenced by aggressive US trade policy.
- Markets are expecting transitory inflation, but we believe the macro backdrop is quite complex, adding to our uncertain outlook.
Divergent policy outcomes
- Fiscal policy in major economies such as the United States, Germany and China has become an influential driver of asset prices, notably US tax cuts.
- We expect a divergence of policy outcomes among Western central banks, as the Federal Reserve (Fed) adopts a “wait-and-see” approach to interest-rate strategy, against a changing US economic backdrop.
- Compared to developed economies, emerging market (EM) central banks have more room to implement policy easing, dependent on trade negotiations.
Portfolio positioning themes
Staying neutral, for now
- Positive news on tariffs has strengthened equity momentum, creating a more constructive setup in the near term.
- However, inconsistent US policy threatens to amplify uncertainty over the medium-term, dampening growth and fueling inflation.
- Against this background, we are recalibrating expectations for equity returns against ongoing market volatility.
US (un)exceptionalism
- We retain our pessimistic view of the United States, particularly small-cap stocks, amid heightened uncertainty and lower earnings guidance.
- The appeal of some international markets has improved, notably Australia and Canada, as both appear likely to benefit from low tariff sensitivity.
- We are optimistic on EM ex China, recognizing relatively healthy earnings growth and a more constructive macro backdrop.
Selective on duration
- US duration may not act as a defensive hedge amid inflation uncertainty, fiscal sustainability concerns and higher-term premiums.
- Markets have scaled back expectations around the depth and duration of interest-rate cuts, curtailing support for bonds.
- Within global fixed income, we prefer eurozone duration while we monitor the impact of tariffs on inflation and growth.
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: 5503658