Summary
Our “risk-on” thesis remains intact heading into September, supported by resilient growth and strong corporate fundamentals despite geopolitical tensions, inflation pressures and uncertainty around artificial intelligence.
We favour diversified equity exposure, retaining a technology tilt while mitigating potential AI-bubble risks.
Inflation and policy remain key market concerns, but robust US and emerging market corporate earnings continue to support our equity positioning.
Elsewhere, we retain a preference for international government bonds amid rising expectations for tighter monetary policy.
Macro Themes
Strong Growth
- Macro growth remains strong, supported by strong corporate earnings power.
- The US economy has proven especially resilient; most estimates of US growth are above-trend.
- Leading economic indicators look healthy, but we are monitoring the impact of higher input costs.
Complicated Inflation
- US inflation dynamics continue to be challenged by a prolonged period of elevated core inflation, although recent data has been more positive.
- We expect limited second-order effects from the energy impulse, as supply driven inflation will reduce real incomes and suppress consumer spending.
- Core goods inflation has marginally improved. Tariff pressures have waned, but we are monitoring global supply chain tightness.
Tighter Monetary Policy
- Heightened tensions in the Middle East have catalyzed a recalibration of policy expectations, with a tightening bias in all major regions including the United States.
- A more hawkish FOMC approach is now priced into markets, as Fed Chair Warsh focuses on reinforcing credibility and independence.
- Fiscal policy is supporting growth but contributing to expanding deficits. Defense spending and energy support packages could also prove influential.
Portfolio Themes
Cross Asset: Risk-On
- Corporate fundamentals remain strong amid double-digit earnings growth expectations for the next 12 months.
- Macro growth remains constructive but is offset by a complicated inflation and policy backdrop.
- Sentiment and positioning have become more exuberant but are not yet at levels of concern.
Equity Diversification
- Our equity exposure is tilted toward AI, reflected as overweight exposure to the US, EMs and Japan.
- European macro and corporate fundamental indicators have improved. Earnings-per-share (EPS) growth forecasts have strengthened amid rising corporate profitability.
- Australian equities remain our least preferred region due to a mixture of weak domestic growth, unsupportive fiscal policies, and tight monetary policy.
Neutral Duration
- We expect demand destruction to have a greater impact on monetary policy decisions than market pricing suggests, decreasing the chance that international central banks meet market hiking expectations.
- Resilient US growth and elevated inflation complicate Fed policy. We maintain a relative preference for international duration.
- Excess returns for equities appear more attractive than credit, amid strong earnings and tight spreads.
Our “risk-on” thesis remains intact as we move into September. Robust growth and strong corporate fundamentals provide a solid foundation for our optimism, despite geopolitical tensions, inflation pressures and AI uncertainty.
We feel comfortable employing a diversified approach to equity investment, retaining a technology tilt while minimizing the impact of any potential AI bubble.
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.
Any companies and/or case studies referenced herein are used solely for illustrative purposes; any investment may or may not be currently held by any portfolio advised by Franklin Templeton. The information provided is not a recommendation or individual investment advice for any particular security, strategy, or investment product and is not an indication of the trading intent of any Franklin Templeton managed portfolio.
WF: 12550508