December 10, 2018

Taking Solace from the Longer Outlook

Allocation Views highlights a pause in equity growth, new volatility and the global liquidity.

Franklin Templeton Multi-Asset Solutions

Every year, when we publish longer-term capital market expectations, it is always interesting to reflect on how our views evolve over different time horizons. Today, with increased market volatility, divergent economic performance and looming trade wars, can we take solace in a constructive longer-term outlook?

Our Capital Market Expectations (CME) are designed to provide annualized return expectations over a seven-year horizon, which approximates the average length of a US business cycle.1 This length of horizon is especially relevant as we proceed toward the latter part of an unusually long economic expansion in the United States. Are we able to look through the risk of a cyclical correction in the intervening years? How are our conviction levels impacted by these risks? Our current Allocation Views and their near-term considerations complements the longer term views in CME.

Major themes driving our views

Is growth divergence a concern?

  • Market concern focuses on a desynchronization of global growth and a less positive outlook than in the early part of 2018. However, key measures of the health of the business cycle remain supportive of a continued period of sustained growth.

How big a risk is inflation?

  • Our central assumption is that inflation pressures will remain subdued, despite being in the later stages of the business cycle where inflation typically rises. However, the risks to wage growth, and to consensus inflation expectations, are skewed to the upside.

Tempered by shorter-term considerations

  • We remain confident about growth staying strong enough to support risk assets over a longer-term horizon. However, investors’ concerns that a pause is close enough at hand to justify reducing risk, tempers our enthusiasm for stocks in the shorter-term.
  • A return to long-run levels of market volatility, rather than the lower levels seen for much of the past ten years, indicates a new volatility regime. As we review our current conviction levels, we tilt toward a more cautious outlook.
  • We favor assets that offer explicit inflation protection such as inflation-linked bonds (TIPS). These alternative assets could provide diversification against any weakness in stocks and bonds because of an unexpected uptick in inflation.
  • As the global liquidity environment evolves, we expect to feel more confident in expressing our longer-term conviction in emerging-market investments. However, we maintain a modestly lower conviction in emerging-market stocks for now.