Staying Nimble Amid an Uncertain Outlook

Our CIOs’ Global Investment Outlook highlights what shocks could affect the market and where they see opportunities.

Bouts of volatility hit markets across the globe in the third quarter of 2019 amid continued uncertainties about global growth and trade. Central banks took notice, with the US Federal Reserve easing interest rates for the first time in more than a decade and the European Central Bank also cutting rates and reintroducing quantitative easing. Against this backdrop, our senior investment leaders discuss why they do not see a recession in the near term, but are taking a cautious and nimble approach.

Q: Recession worries dominated media headlines recently. How do you respond to these concerns?

I think we need to look at what causes a recession. When an economy is overheating, monetary policy plays a traditional role to cool it down. This business cycle feels a bit different. We don’t have those classic signs of overheating, but we have a lot of moves that seem to be preemptive—whether that’s US fiscal policy stimulus or actions of central banks globally.

The big issue right now is trade policy uncertainty. Not just from the standpoint of the impact on the real economy, but maybe more importantly, the question of how the situation could be resolved, or how much more could it escalate. The uncertainty about trade has put a bit of a lid on the outlook for equities. That said, I would note US equities are actually near all-time highs.

I think it’s important to point out the global economy has changed over the past few decades. Gross domestic product growth is less manufacturing-driven and more service-driven—and this is the case not only in most developed countries but in a number of emerging markets, too.

Globally, one can argue the manufacturing side is currently in recession, but the service economy is not (see exhibit 1).

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  • Chief Investment Officer, Fixed Income Group
  • Head of Equities
  • Chief Investment Officer, Templeton Global Macro
  • Chief Investment Officer, Franklin Templeton Multi-Asset Solutions

SERVICE ECONOMY REMAINS IN EXPANSION, WHILE MANUFACTURING DECLINESExhibit 1: Global Purchasing Managers’ Index (PMI) September 2016–August 2019

Exhibit 1: Global Purchasing Managers’ Index (PMI) September 2016–August 2019

Sources: Franklin Templeton Capital Market Insights Group, IHS Markit Global Services/Manufacturing PMI, Macrobond. Important data provider notices and terms available at

The Global Sector Purchasing Managers’ Index (PMI) tracks variables such as sales, employment, inventories and prices. A reading above 50 indicates that the sector is generally expanding; below 50 indicates that it is generally declining.

Meanwhile, earnings growth hasn’t been what we had hoped for earlier in the year, so there’s also some talk of an earnings recession in the sense that earnings growth has slowed compared with recent years. While predictions still look pretty positive for 2020, earnings could certainly come down a bit. We are still relatively positive on our outlook for equities—corporate profits remain high, even if their growth is diminishing a bit. We still see a lot of potential opportunities right now but recognize that fears about a recession and negative news can indeed be self-fulfilling prophecies. When businesses are uncertain, they tend to pull back.

I think we should be asking ourselves: “What are the forces that have been holding up market performance?” Going back to the risk of recession versus the fear, if uncertainty rises to a degree where corporations really start to pull back on capital expenditures, that could be a self-fulfilling mechanism that does slow growth.

One of those sustaining forces is buybacks—which hit a record of more than $800 billion in 2018 in the United States.1 I think it’s interesting to look at the difference between the absolute earnings of all companies and earnings per share (EPS), which represent a company’s profit divided by shares it has outstanding. Absolute earnings growth has been less than earnings per share growth due to share buybacks, particularly in the United States. Buybacks can create distortions in the equity market, particularly in terms of valuations. Stock prices tend to appreciate more than they would if there were no buybacks, and at least in the United States, buybacks have really been propelling the market. Buybacks can be considered a form of demand for equities—since they involve a purchase of shares. Lastly, money from buybacks that is returned to shareholders wouldn’t be available to investing back into the business to fuel growth.

When I look at EPS growth because of buybacks, it brings us to a discussion of an unusual quantity of liquidity. It’s essentially financial engineering. But what I find interesting is we are really talking about a possible earnings recession—not a real economic recession. I absolutely agree that firms could start becoming a lot less confident about the outlook and that can impact investment.

On the other hand, we continue to see very robust wage growth (see exhibit 2). So, I would agree that we might see an earnings recession play out if we aren’t already, but I’m not so sure it’s translating near term into a recession in the real economy in the United States.

STRONG US SAVINGS RATE AND WAGE GROWTH TRENDS WITHOUT DEFLATIONExhibit 2: US Bureau of Economic Analysis (January 1990–April 2019)

Exhibit 3: US Bureau of Economic Analysis January (1990–April 2019)

Sources: FTI Fixed Income Research, US Bureau of Economic Analysis (BEA), Macrobond. The core Personal Consumption Expenditures (PCE) excludes food and energy prices from the index.

Q: What’s your view of monetary policy globally—and the implications for investors?

If we were to look back 10 years ago, the thought that central banks would be cutting interest rates when wages were going up, when there is record-low unemployment, decent economic growth and strong budget deficits would seem pretty unconventional. Quantitative easing programs in the wake of the 2008-2009 global financial crisis were unconventional—and they worked really well. So, central banks across the globe are now doubling down on unconventional policy during a different fundamental backdrop—one that is much stronger—and we just don’t know what some of the results of this policy experiment will be. The idea of negative interest rates has become very normal. I think we have to question that thinking. Negative rates can be counterproductive.

When you have a lot of savers facing a negative return on their bank accounts and their savings, they tend to save even more and spend less and so it’s counterproductive. We need to consider whether these exceptionally low interest rates are artificially pushing investors seeking better yields into riskier assets at higher valuations and perhaps less liquidity. So, I think policy decisions are where the biggest risks lie because they are creating some distortions, which could trigger a recession.

I don’t see how it can end well when central banks—particularly the US Federal Reserve (Fed)—seem to be guarding against a perceived threat of deflation. There’s absolutely no sign of deflation anywhere in the United States, so this complete focus on guarding against this threat seems strange to me. With record low US unemployment, the Fed seems to be anticipating a deflationary situation that doesn’t seem to exist, and effectively keeps pushing investors towards riskier, less liquid assets. If we look at wage growth combined with the impact of US-China tariffs, at some stage, we have to actually consider a rise in inflation.

From the equity point of view, while we see many opportunities globally in markets, we are also quite cautious. I think equities, at this point, are a yield opportunity. The yield on earnings is still much higher than the yield on fixed income (see exhibit 3).

EARNINGS YIELD IS HIGHER THAN THE YIELD ON FIXED INCOMEExhibit 3: Global earnings yield and government bond yield (August 2001–August 2019)

Exhibit 5: Global earnings yield and government bond yield (August 2001–August 2019)

Sources: Franklin Templeton Capital Market Insights Group, MSCI, Bloomberg, Macrobond. Important data provider notices and terms available at For illustrative purposes only and not reflective of the performance or portfolio composition of any Franklin Templeton fund.

The MSCI Europe, Australasia and Far East (EAFE) index captures large- and mid-cap representation across 21 developed market countries. Indexes are unmanaged and one cannot directly invest in an index. They do not include fees, expenses or sales charges. There is no assurances that any estimate, forecast or projection will be realized. Past performance is not an indicator or guarantee of future results.

As central bank activity continues to push investors into riskier assets, the broader drift downwards in global rates has implications for corporate borrowing costs as well. We have seen a real pickup starting to happen in credit markets; companies have been able to access longer-term capital at incredibly low rates. This ties back into our discussion about the bigger positive drivers for equities—namely share repurchase activity. While we may see a slowdown in earnings growth going forward, corporations do still have access to capital, so they can sustain share buybacks.

As multi-asset investors, when we look at negative sovereign rates around the world, and very low absolute yields in the broad range of fixed income sectors in the United States, at some point we have to ask where the alternatives are.

One of our themes continues to be taking an active approach in a period of potentially high volatility.


  1. Source: S&P Global press release, March 25, 2019, “S&P 500 Q4 2018 Buybacks Set 4th Consecutive Quarterly Record at $223 Billion; 2018 Sets Record $806 Billion.”

What Are the Risks?

All investments involve risks, including possible loss of principal. Bond prices generally move in the opposite direction of interest rates. Thus, as the prices of bonds adjust to a rise in interest rates, the share price may decline. Investments in foreign securities involve special risks including currency fluctuations, economic instability and political developments. Investments in emerging market countries 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. Such investments could experience significant price volatility in any given year. High yields reflect the higher credit risk associated with these lower-rated securities and, in some cases, the lower market prices for these instruments. Interest rate movements may affect the share price and yield. Stock prices fluctuate, sometimes rapidly and dramatically, due to factors affecting individual companies, particular industries or sectors, or general market conditions. Treasuries, if held to maturity, offer a fixed rate of return and fixed principal value; their interest payments and principal are guaranteed.