Global Investment Management Survey: Outlook on recession and more

Transcript:

Chris Galipeau: It's good to be with you. 

Host: Chris, I can't believe it's the middle of May already with summer quickly approaching. It has certainly been an interesting year to date in the capital markets. When thinking about just the last 5-6 weeks, do you have any initial thoughts on the market action?

Chris Galipeau: Yeah, never a dull moment in our business, right? I think when you think back just from the start of the year, you had the S&P 500 [Index] at a new high in the middle of February, and then, of course, economy and whatnot on sound footing, corporate profitability, on sound footing. And then we get the [Trump] tariff announcement, which I think it's safe to say, shocked everybody in terms of the order of magnitude of what was being proposed. And, of course, the market does not like to be surprised and did not take that well. And so you had a pretty substantial pullback there, peak to trough, about 22% in the S&P [500], more in the NASDAQ. And what really happened there I think was the market not liking uncertainty number one, which is pretty obvious. But if you actually go through the math of that pullback, the S&P [500] consensus estimate for the year was about $275. The multiple was somewhere north of 22. And so the market was immediately reacting and pricing down the impact on forward EPS [earnings per share] growth—took about five multiple turns out. And we traded down to about 17, 17.5 times. If you actually do the math on that five multiple turns times the estimate, it's almost not perfectly exact, but pretty darn close to where the S&P [500] adjusted itself to. So, market moving ahead of earnings degradation. That's very normal. And you get into a period where it feels cathartic, right. Where you get indiscriminate selling which then tends to lead to a capitulatory event, which is exactly what we had on Monday April 7th. That was our view at the time. I think we did a good job with that.

And then slowly, right when you feel like you can't possibly see yourself or see a way out of the problem, whatever it is, in this case it was tariffs. COVID was the same thing. GFC [global financial crisis] was the same thing. 9/11 was the same thing, right? Long Term Capital [Management], same thing—going back in time. It's at that point of maximum uncertainty and maximum fear and feeling like the stock market is on the way to zero. That's generally the time where you need to take some action, where you need to turn the dial up on risk, turn the dial up on equities, for example. And that frankly runs counter to emotion. And a lot of folks will say, “hey, it's different this time. It's different this time.” It's never different this time. The cause of the problem is always different. But what never changes is human behavior and the reaction to those events. And we've seen it through history. The stock market usually—not usually—the stock market does recover.

So the market has rallied back substantially here. S&P is now up for the year. So we've rallied about 22-23% from that low in April. And the rationale for that or the reasoning for that is really just the worst-case scenario being priced in there in terms of economic impact, in terms of earnings impact, and then slowly starting to see some green shoots, i.e., 90-day [tariff] pause initially for every country ex China and then a moratorium or a stay of execution on electronic components. And then recently the 90-day stay of execution on China and then some deals announced i.e., UK, and probably more in the pipeline. So I think that has taken the worst-case scenario off the table here. And of course now the market has reacted to that. Now I would say the S&P is back to 22.5 times earnings, earnings, probably somewhere around $265-ish, something like that, maybe a little bit lower.

You had the opportunity there in April where the risk-reward was strongly in your favor, even though it didn't feel like it emotionally. But that's the way it works and that's the way the stock market works. I don't know that I would chase this from here, you know, just north of 5900. So there are years when nothing happens and then there are weeks when years happen. And that's exactly what just happened.

Host: So given what you just laid out there, is there anything that you would emphasize to investors who are listening to our conversation today just to think about lessons learned?

Chris Galipeau: Yeah, definitely. I think that this should serve as a reminder that it's important to stay with your long-term plan. And if you're working with an advisor, even better. You have them and their resources and their tools to keep you on the glide path.

Remember why you're investing. Remember that you're investing over long periods of time, and that the market does dislocate from time to time, and pullbacks of 10% or, you know, 15% are normal. And if you find yourself in a scenario where what happened in April was really disturbing and was unnerving, then perhaps go back and relook at the plan and make sure that your asset allocation is in line with your true risk tolerance. Right? So if April didn't bother and you stayed with the plan, perfect. If it stressed you out and caused you to lose sleep, then perhaps you might have a little too much risk on the table. So that's the first thing.

And I think the second thing would be the power of diversification is important. And so having your equity exposure diversified by style, by cap size, by geographic location, right? So having exposure outside of the United States is important, and the kind that will ebb and flow over time. But I think those are probably the two primary things there. Be able to stick with your plan. Know if you have to adjust your plan, if that selloff took its toll on you mentally. It certainly did profitability-wise there for a little bit. And then, make sure that the portfolio is properly structured, that over time it will compound the way you'd like it to.

Host: Chris, that's great insight. Thank you for providing that and also giving us a view of what's happened here over the last 6, 7 weeks. Now, let's take a turn and look ahead. I know that the Franklin Templeton Institute has recently surveyed all of the Franklin Templeton portfolio managers throughout your ecosystem for your mid-year 2025 Global Investment Management Survey. Can you just remind our listeners what the objective is for that survey?

Chris Galipeau: Sure. So the objective of the survey—and we do this twice a year—so we do it in the fall after Thanksgiving in preparation for the next calendar year. And then we go through an update process in the middle part of the year. So we just went through the update process.

What we're trying to do there is very simple. Franklin Templeton manages somewhere in the ballpark of $1.6 trillion. We have a 1,000+ investment people, 400+ named portfolio managers, all asset classes all over the world. And our objective there is to really just take their temperature, right? Ask them very specific and highly detailed questions about how they're thinking on a go-forward basis.

So in this case, we wanted to get their updated thoughts through the end of calendar year 2025. As we just spoke to, a lot has changed since January 1. So that's the goal. And it's really to harness the investment wisdom and intellect of all the portfolio managers across the organization. And then we then take that information, and that essentially builds the foundation for the outlook for the organization on a go-forward basis.

And of course, we share that with our clients. And, so, there's an awful lot of information in there. There's a lot of very good nuggets. We can see where the portfolio managers have high levels of conviction regardless of asset class. We can also see where the outliers are. And so we can understand what managers might be concerned about.

It's very important also to go through and understand the risks to the current outlook. What you know, what could make us be wrong here? What are the three most important things to think about here as we present our thoughts for the balance of the year? So that's generally the process and very informative, always with a lot of excellent information and intelligence we can pass on to our clients.

Host: That makes a lot of sense, Chris. And you mentioned in your comments there change. Is there any dramatic, maybe even remarkable change in the view of your portfolio managers regarding the economy?

Chris Galipeau: Yes. So with regard to the economy, we came into the year coming on the heels of two very strong years for real GDP [gross domestic product] in the United States, roughly 2.4% to 2.5%. That's above the long-term trend growth of the US economy, which is about 2%. Enter the tariff discussion, and that is likely to put downward pressure on real GDP here. And so we've adjusted the number down into a range of about 1.5%, which is, you know, a little below long-term trend. I think interestingly, of course, you see in the media and you hear from other firms and whatnot—and quote unquote experts talk about this—a lot of talk of recession.

You know, we ask our portfolio managers across the organization, what do you think the chances of recession are considering what has happened? And a full 75% of Franklin Templeton portfolio managers told us they are not worried about recession, meaning they don't think that's where we're headed. And there were a couple that did. Even those that thought it's a possibility thought it would be very mild.

So that's kind of the macro backdrop. And the other part of that that's important at the same time is the inflation part of the calculation. So, core inflation has been steady now for 10 months at about 2.6%. The as low as it's been since 2021 down about 55% from its peak. The tariffs are probably going to cause some sort of inflationary impulse.

And it's probably going to be something along the lines of a one-time price inflection. And so we have raised the inflation target to somewhere around 3.25%. And it could be a little bit higher than that. So it's a combination of slower real economic activity along with a little bit of an inflation impulse here.

People would say, do you think that that’s stagflationary? Not necessarily. I mean, I think the unemployment rate might tick up a little bit as well. At least that's the view of our portfolio managers, but not to something like 8% or 9%, which would be slowing GDP with high inflation and that sort of backdrop, unemployment, would be probably the worst-case scenario. And that is not our base case at all. So those are the big changes with the thought process around the economy.

Host: Makes sense. So with that foundational point of view on the macroeconomic environment, how about the outlook for US equities?

Chris Galipeau: Okay. So we came into the year with the thought that the S&P could trade somewhere in the 6400 level, maybe a little bit higher. And that was predicated on a few things: inflation continuing to come off the boil, pulling 10-year rates down, earnings estimates somewhere around $275 all in at the index level, and a multiple—because things seemed pretty robust economically, with inflation ebbing—and a multiple that could hang in there somewhere around 23 to 24 times, which frankly, is a huge number.

Long-term median forward multiple for the S&P is about 16.5, 17 for the long-term median multiple since 1990, which is when I started, is about 19. So that's a big multiple and a big number for the S&P. And we told the clients that if there really is no safety net up here, if something goes wrong, that there's no chance that that target will be right. And then we got the tariffs scenario.

So thinking through that now, a few things, right? As we just discussed, the economy's likely to back down here a little bit. Even we don't know the rules from the tariff program yet. And so as management teams are evaluating this and thinking this through, they are going to sit on their hands with regard to Opex [operating expenditures], with regard to Capex [capital expenditures], so on and so forth.

And so that alone is, I think, putting some downward pressure on the economy. And then they will get the rules here at some point in the next, I don't know, 3-6 months probably on tariffs. Once they have those rules, they'll be able to make some changes. But I think it's reasonable to expect upward pressure on cost of goods sold and in some cases, and additionally they'll be the price elasticity of demand.

There could be if the companies want to pass the prices on, there could be downward pressure on revenue at the same time as there's upward pressure on COGS [cost of goods sold], which will put pressure on gross margin, operating margin, net income margin and net income and ultimately on earnings. And so we've lowered the target range down to 5500-5900. And we're at the top end of that range here now.

So using the consensus number of about $264, the tape is trading 20 almost 22.5 times that right now. So remember that the stock market is a forward-looking animal. It discounts, it anticipates. And so from the panic lows of April to right now, the market has snapped back and responded, thinking that “okay, earnings probably aren't going to be faced with the worst-case scenario.”

So I think the better part of valor here in terms of new money is to be patient. I don't know that I would chase this market here. I think positioning is still very offsides. Sentiment is offsides. And I know we're going to talk about that. So it could get squeezed up a little bit higher. I think the most important thing though is not necessarily what the S&P quote unquote target is.

It's what should investors own and how should they have their equity exposure structured? And I think that's much more important, because ultimately that's what we have to do as investors. So our most highly convicted recommendation or viewpoint coming into the year was the notion that the stock market would broaden out. And as a matter of fact, the stock market has been broadening since July of last year. Very quietly. And a couple observations there. Number one, the quote unquote average stock, which I measure by looking at the equal-weight S&P versus the market cap-weighted S&P, has outperformed now for nine months, 10 months. And the reason for that is earnings power looks much broader now. And granted, the tariff situation throws a curveball into that mix a little bit.

But it looks much broader than it has at any point in the last five years. And so that's been our advice. Make sure you're not strongly tilted in one direction, either growth or value. Make sure you have exposure to both. Make sure you have some exposure down the cap stack. Make sure that the emphasis in your exposure and that the managers that you're hiring, or if you're doing it yourself, you have a high degree of focus on quality metrics or quality factors, i.e., free cash flow yield, high return on invested capital, strong return on earnings, low net debt to EBITDA [earnings before taxes, interest, taxes and depreciation]. Better said strong balance sheets. Right? Focus it there. Make sure you've got some exposure outside of the United States. The fact of the matter is, on a go-forward basis, the cumulative earnings power in Europe, EM, India, Japan for example, is equal to or better than what we have in the United States, for the next two years.

So I think you need to be properly diversified and structured. And to me, that's a lot more important than picking a range on the S&P [500], because our clients are going to own way more than just the quote unquote S&P. They're going to have the portfolio diversified.

Host: So that's fantastic. You mentioned so many things there. There is no safety net. We still have the tariff uncertainty. It's really important to be well diversified and to be focused on, you know, your long-term goals. You still see opportunity. You mentioned some opportunities potentially outside of the United States. Let me transition to a different topic here. We are hearing quite a bit in the financial media about the hard data and the soft data, and that the hard data and the soft data isn't necessarily aligned. Provide some perspective there, Chris.

Chris Galipeau: Okay, so you're right. There's a lot of focus on investor sentiment. There's a lot of focus on consumer sentiment and so we track all of those metrics. And those are the soft data points, the surveys.

The hard data points i.e., the PMI [Purchasing Managers Index] data, the actual inflation data, the jobs data, even just those three metrics alone have held up very well. The most recent [US] jobs report was robust. We're still operating at full employment. And to be honest, that's probably the most important thing when it comes to sentiment. Right? And what consumers are likely to do. We all drive two-thirds of GDP. So as long as we're employed and feel reasonably comfortable there, then we're probably not really going to curtail the spending.

And we've seen that. If you listen to the most recent earnings reports from yesterday—Walmart, I was on that call and listened. They did talk about the tariff thing. They might pass some prices. But the shopping and traffic in this store is still robust. We heard the same thing from American Express, Visa and Mastercard, the big credit card companies who track spending in the extension of credit. We heard the same thing from Bank of America, JPMorgan, Citigroup and Wells Fargo. So if there was any real problem under the surface, those are the companies that would see it first in their hard data. They haven't seen that at all. So I think what we're dealing with here is a scenario where this shock-and-awe tariff campaign and frankly, the chaotic approach to it here in the first half of the year has really unnerved people. I think that's important to recognize. That doesn't necessarily mean that people are going to change their spending habits.

And it's interesting if you actually look at the survey data, i.e., the soft data, and you use something like consumer sentiment. So we just got an updated consumer sentiment number this morning. It's at one of the lowest levels going back to the late ‘70s. And if you actually look at those periods where consumer sentiment, I think the last tick was in the mid-50s this morning. If you look historically, periods when consumer sentiment is under 60 (so people are negative), this is one of the lowest readings we've ever gotten in history this morning, right in line with 2022, right in line with 1980. Those are the only two periods that have been tied or weaker.

If you look at the behavior of the stock market one year out from these readings. So if we take today one year out into next May, here's what the stock market does with that. The median forward one-year return for the S&P 500—and this is just the data this is not an opinion—this is the actual empirical data. The median forward return one year out from consumer sentiment readings under 60 is 27%. The hit rate, meaning the accuracy every time it trades under 60 is 80%. There was only one period, which was in the summer of ‘08 (of course, that was the start of GFC) where the one-year return was not positive.

So my point there is: whether it's consumer sentiment, whether it's investor sentiment, which we track closely when people are worried, normally that's from the headlines and usually that coincides with the period that is maximum uncertainty—and you could even say it's maximum fear—those  are the periods when the stock market bottoms and goes up. And that's exactly what's happened here.

We saw in April the consumer still worried. The investing public generally is not constructive. Those are good setups for risk assets on a go-forward basis. And I know that that might seem counterintuitive, but that's the way the stock market works. It looks forward, it discounts, it anticipates. It does not look through the rearview mirror.

Host: Chris, thank you for laying that out. Very, very interesting. I've got a couple more questions. I want to just give you an opportunity to maybe provide your perspective on recession. Earlier, you mentioned that the Franklin Templeton portfolio managers’ aggregate consensus view of recession has dropped dramatically. Do you have any insight that you wanted to share with our listeners?

Chris Galipeau: I think I agree with the portfolio managers. I think objectively evaluating the data, the hard data, in light of or comparing it to what the soft data says, we have enough information that would tell us this really doesn't feel like it's lining up for recession. And if you think about it, in most of our careers, the mechanism to cause a recession has been a combination of the following: the Fed [Federal Reserve] raising rates and being restrictive for too long, leading to creating potentially a credit crisis or a liquidity crisis. You could even get the funding markets to break, like happened a little bit in COVID, meaning money-market system and repo system isn't working properly and the plumbing and credit markets is not functioning properly. There was some concern about that, frankly in April. Everything was fine, but people were starting to get worried about it. We haven't seen any financial institution get in trouble. Those are typically the markers of we're heading into recession. We don't see that.

Host: So Chris, as we've now crossed over the midpoint here in the second quarter of 2025, I'm wondering what you and your team are looking at, what you guys are watching as it relates to the capital markets for, you know, really the remainder here of the year.

Chris Galipeau: Yeah, it's a great question. I think what we need to keep our eye on here and keep the pencil sharp with is we don't know the rules yet with regard to the tariffs, meaning we don't know the levels. Once the companies get those final rules, they will then start to pull levers and make adjustments. It could be supply chain. It could be, are they going to eat the cost? Are they going to pass the increased costs on? Are they going to put pressure on the suppliers to manage some of that cost for them or help them? It's probably going to be all of the above. I think what we're going to find here is some companies will be in the crosshairs of this and might really struggle where other companies won't be affected in terms of order of magnitude that some other companies might. So I think we'll continue with the separation of the wheat from the chaff here. So I think we need to pay attention to that. What the actual impact is going to be on earnings power across market cap, across sector, across industry. That's probably number one most important thing.

Number two would be what is the administration's plan here going forward and thinking forward with regard to budget reconciliation and the extension of the Tax Cuts and Jobs Act? So they're working on that now. We've seen a lot of headlines there. What's that going to look like in its final form? And then finally, what about the deregulation talk? How is that going to fall out? What are the impacts of that likely to be? So it would be tariffs and impact on earnings. It would be what happens here with the budget process and the tax cuts. And then the deregulation part to follow. And I think that's going to take some time to play out here. But those are the areas that we'll be focused on, on a go-forward basis.

Host: Terrific. Now, Chris, as we look to close out this afternoon's conversation, do you have any closing thoughts for our listeners?

Chris Galipeau: Well, I think it might go back to what we talked about at the onset of our chat, which is what would you emphasize for investors and this is a couple things. Periods of volatility are very normal. In the last few years, we've been lulled to sleep a little bit where it's not a foregone conclusion that stock prices will just go up. I'm sorry to tell you that, but stock prices can, do and will go down. So make sure that the portfolio is structured to be able to achieve your objectives and mostly manage your risk.

I think that's probably the most important thing. Number two, stick with the long-term plan. Which leads me to number three. Try not to get wrapped up in what you hear on TV or what you read. That can be a very dicey game and without question, hesitation or reservation, that is exactly what has happened here in the last few months.

Now, granted, it's been chaotic. It's been confusing. I watch all of it all day long, and there are some days when I'm not sure if I should take a left or take a right. It is confusing, but knowing and believing that over time, stock prices track earnings growth on a go-forward basis. That is the most important variable to think about as you think about the stock market.

And I think what history proves is that through any sort of dislocation, calamity, you name it, wars, COVID, the financial system on the brink like it was in ’08 and ’09, earnings growth does recover and goes on to accelerate, which of course pushes the stock market up over time. But it's not a straight line. And I think this served as a good reminder of exactly that. Right. And stay diversified.

Host: Chris, thank you for your time and for your wonderful insight. To all of our listeners, thank you for spending your valuable time with us for today's update. If you'd like to take a look at the Franklin Templeton Global Investment Management Survey update for mid-year 2025, head to our website at franklintempleton.com/insights. If you'd like to hear more Talking Markets with Franklin Templeton, visit our archive of previous episodes and subscribe on Apple Podcasts, Google Podcasts, Spotify or through any other major podcast provider.

Survey methodology

Bi-annual survey: This bi-annual outlook survey is designed to give a view across our investment teams. The Franklin Templeton Institute identifies the median across answers and develops commentary on the year ahead.

Investment professionals across all asset classes: The Franklin Templeton Global Investment Management Survey received responses from more than 200 portfolio managers, directors of research and chief investment officers. This represents a participation across equity, private equity, fixed income, private debt, real estate, digital assets, hedge funds and secondary private markets.

Aggregate views: This survey gives an aggregate view by taking the median of the answers. Questions included macroeconomic, equity and fixed income views.

Independent views: Each of our investment teams are independent and have their own views. This survey serves as a starting point to their best ideas.

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This material reflects the analysis and opinions of the speakers as of May 16, 2025, and may differ from the opinions of portfolio managers, investment teams or platforms at Franklin Templeton. It 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. 

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