Allocation Views

Franklin Templeton Investment Solutions

A LITTLE MORE CLARITY?

As we enter 2021, financial markets appear to be clinging to a more optimistic view of the world than the one we left behind in 2020. Undoubtedly we have reasons to be more hopeful, but it seems that we still have a greater than usual level of uncertainty over a number of factors that are key to how markets react during the coming year.

Focusing on the United States, the political environment is becoming clearer, with the narrowest of victories in the Senate race being confirmed for the Democrats after runoff elections in the state of Georgia. This may open the way for more significant fiscal stimulus to be enacted in the early part of this year, supporting ongoing consumption growth. However, even as the transition to President-elect Joe Biden seems likely to occur on schedule, as legal challenges have fallen away, it is clear that the political landscape is more deeply divided than ever. For now, financial markets have taken this in their stride, but we suspect that US politics may remain a source of continued uncertainty over the months ahead.

Equally, the progress toward authorizing multiple, highly effective vaccines against the coronavirus that causes COVID-19 continues apace. The realization that we have light at the end of the tunnel has been the primary narrative supporting risk assets over the last two months. We share this optimism and remain hopeful that even as the virus mutates and evolves, medical science is likely to be able to keep pace with the challenge. However, the near universal agreement with this positive view leaves scope for any near-term disappointment to hurt investor sentiment. A new element of uncertainty emerges regarding logistics around vaccine distribution, and the willingness of the populace to take it.

Similarly, the re-imposition of harsh lockdowns in many European countries, to avoid health services being overwhelmed in the face of a new, more contagious variant of the virus, is worth noting. The relative lack of concern in markets sits uncomfortably with events that are having such a dramatic impact on populations in these countries and may lead to double-dip recessions in some. We have commented in Allocation Views over the last six months that humanity is very good at adapting to known challenges and learning from prior experience. It is probably the case that markets are right to say, “we know how this story goes” and look through the near-term disruption to a better future. However, it may also reflect fatigue with reading bad news and a degree of complacency over some of these risks.

Taken together, we continue to believe that the deep global recession we saw in 2020 is behind us and a new expansion is well-established. We share the more optimistic expectations of the likely pace of growth, led by near full recovery in China, and as 2021 evolves, especially in the United States. However, the near-term risks from the continued threat of COVID-19 leave us with an outlook that is less clear than usual. As a result, we retain a slightly cautious view, encapsulated in our theme that sees “Elevated Uncertainty over the Pace of Global Growth.”

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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.