United States
Allocation Views
Hold the course.
PREVIEW
As the world adjusts to life with the specter of COVID-19, it is increasingly clear that much has changed. We have become used to social distancing and unimaginably weak economic data. However, although we have become familiar with these new features of our lives, we hope that they will not be with us for too long!
One thing has not changed, and perhaps it is a fundamental feature of financial markets: government bond investors typically see the glass as half empty, whereas equity markets are the more optimistic half of this comparison. Part of the conundrum relates to investment horizon. Stockholders typically buy into optimism, with the promise of longer-term growth or the realization of underappreciated value. Meanwhile, bond investors worry about not making it quite that far, and are more concerned about whether they will be paid their next coupon.
When we listen to central bankers such as US Federal Reserve (Fed) Chairman Jerome Powell, they are aligned in their message of doing “whatever it takes.” As we discussed last month in Allocation Views, calls for the coordination of monetary and fiscal policy have become a new normal. But we also hear something like the “pragmatism” of a bond investor speaking to us. Despite the Fed cutting interest rates to effectively the zero bound and providing an array of lending programs to underpin liquidity across financial markets, Powell worries that it might not be enough. Interest-rate futures markets also share some of this concern and have moved to discount the possibility of rates falling below zero in the United States, even though the Fed strenuously resists this notion.
Powell also worries about the lasting effects a recession could have on business investment and the impact on productivity growth and incomes. This is why the Fed is emphasizing the need for fiscal stimulus while continuing to buy US Treasury and mortgage-backed securities in whatever amounts are needed to support market functioning. It promises to do so until the United States is well on track to attaining the Fed’s inflation and employment goals. Powell’s peers at all the major central banks share such uncertainties over the outlook.
The outlook in Europe is at least as uncertain as it is in the United States, and European Central Bank (ECB) President Christine Lagarde seems similarly concerned. The ECB has introduced new refinancing and liquidity operations, but like the Fed, it is not in the business of handing out public money; that is the preserve of elected governments and hopefully in the medium term, a collective European Union (EU) effort. Lagarde’s difficulties were compounded by the recent German Constitutional Court ruling against the European Court of Justice’s support for the ECB’s asset purchase program. We do not believe that this will result in a premature end to this program, but it does present an obstacle and shows the EU in a poor light. Despite this, Lagarde seems intent on leaving the markets under no illusion that the central bank will hold the course.
The global economy is already in a severe recession, and it is unclear how smoothly the phased release of lockdowns will be. A second wave of infection might lead to renewed restrictions and a slower recovery. Reflecting the balance of issues noted above, we are focused on the potential for the risks in the near term to remain skewed to the downside.
As a result, this leaves us with a relatively cautious view, encapsulated in “Significant Headwinds to Global Growth.”
WHAT ARE THE RISKS?
All investments involve risks, including possible loss of principal. The positioning of a specific portfolio may differ from the information presented herein due to various factors, including, but not limited to, allocations from the core portfolio and specific investment objectives, guidelines, strategy and restrictions of a portfolio. There is no assurance any forecast, projection or estimate will be realized. Stock prices fluctuate, sometimes rapidly and dramatically, due to factors affecting individual companies, particular industries or sectors, or general market conditions. Diversification does not guarantee profit or protect against risk of loss. Bond prices generally move in the opposite direction of interest rates. Thus, as the prices of bonds in an investment portfolio adjust to a rise in interest rates, the value of the portfolio may decline. Special risks are associated with foreign investing, including currency fluctuations, economic instability and political developments. Investments in emerging markets, of which frontier markets are a subset, involve heightened risks related to the same factors, in addition to those associated with these markets’ smaller size, lesser liquidity and lack of established legal, political, business and social frameworks to support securities markets. Because these frameworks are typically even less developed in frontier markets, as well as various factors including the increased potential for extreme price volatility, illiquidity, trade barriers and exchange controls, the risks associated with emerging markets are magnified in frontier markets. Derivatives, including currency management strategies, involve costs and can create economic leverage in a portfolio which may result in significant volatility and cause the portfolio to participate in losses (as well as enable gains) on an amount that exceeds the portfolio’s initial investment. A strategy may not achieve the anticipated benefits, and may realize losses, when a counterparty fails to perform as promised. Currency rates may fluctuate significantly over short periods of time and can reduce returns. Investing in the natural resources sector involves special risks, including increased susceptibility to adverse economic and regulatory developments affecting the sector—prices of such securities can be volatile, particularly over the short term.
IMPORTANT LEGAL INFORMATION
This material is intended to be of general interest only and should not be construed as individual investment advice or a recommendation or solicitation to buy, sell or hold any security or to adopt any investment strategy. It does not constitute legal or tax advice.
The views expressed are those of the investment manager and the comments, opinions and analyses are rendered as at publication date and may change without notice. The information provided in this material is not intended as a complete analysis of every material fact regarding any country, region or market.
Data from third party sources may have been used in the preparation of this material and Franklin Templeton Investments (“FTI”) has not independently verified, validated or audited such data. FTI accepts no liability whatsoever for any loss arising from use of this information and reliance upon the comments opinions and analyses in the material is at the sole discretion of the user.
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