What Franklin Templeton Thinks...

Q3 2019

The thoughts of our investment managers on current market topics and key themes.

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What Franklin Templeton Thinks

…About TRADE & TARIFFS

Trade Rhetoric Has Tapped the Brakes on Business Investment

  • Uncertainty weighs on business and investors.
  • Although the direct effect on trade from tariffs has so far been small, the disruptive potential is high.
  • New export orders have been falling sharply for the past year and warn of a continued trade slowdown in the second half of the year.
  • Much of the economic weakness is linked to China and regional trading partners, but Japan has suffered a sharp deterioration in exports, while German manufacturing confidence was recently at levels not seen since the depths of the eurozone crisis in 2012.
  • However, trade conflict reflects the frustrations of populations rejecting globalization and turning inward.
  • Our baseline scenario is for a US China trade deal in the second half of 2019, but tail risks have increased, so flexibility to handle volatility is key.

…About GLOBAL EQUITIES

Change of Mindset May Be Required

  • Markets appear to be transitioning from a momentum driven to a range trading environment.
  • Global equities still have the earnings to support their values, but profit margins may come under pressure.
  • The potential for renewed market volatility warrants caution.
  • In Europe ex UK, economic activity has slowed due to global trade concerns and weaker manufacturing activity.
  • We are cautiously optimistic on the prospect of stabilizing conditions.

…About US EQUITIES

Uncertainty Gripping Markets Gives Us Pause, But Recession Appears Unlikely

  • Slight deceleration in global growth, including US of late, is making us a little more risk averse.
  • Despite the trade tensions, growth has remained stronger in the US than in other developed markets.
  • The stock market’s attention will focus on corporate earnings growth, margin pressure and , in particular, Fed policy.
  • For example, 50% of the US equity market rise year to date (June 30) occurred in the 2 day aftermaths of 3 dovish Fed chairman statements.1
  • Value remains out of favor; we don’t expect this trend to last indefinitely.

…About BREXIT

‘ Brextension ’ Gives Breathing Room but No Clear Path Forward

  • Little progress has been made since EU member states granted the October 31 extension.
  • Both Conservative leadership contenders said they would try to reopen negotiations with the European Commission; no reciprocal response.
  • A “no deal” scenario is the default if no agreement is reached.
  • We have a neutral view on the UK for the time being with the positives of high corporate profits and robust labor markets offset by trade risks, slowing global growth and Brexit.

…About EMERGING MARKETS

Attractive Valuations Lead to Optimism with One Elephant in Room

  • Fed policy normalization no longer seems to be a headwind.
  • Longer term attractive attributes coming to fore, including improved corporate governance as a structural driver for EM equity re rating.
  • Despite attractive valuations, we are cautious on China; the economy has stabilized but the rhetoric has hardened.

…About INTEREST RATES & INFLATION

Fed Potentially Trading Less Volatility Today for More Down the Line

  • The US market has declared at least one interest rate cut a done deal, yet economic data doesn’t necessarily support this stance.
  • The concern is that any cut(s) will be driven entirely by market (and political) pressure, rather than inflationary pressures.
  • Interest rate risk doesn’t end with US Treasuries; it’s baked into asset classes across financial markets.
  • We do not expect either the European Central Bank or the Bank of Japan to pull back on their accommodative policies this year, due to slowing global growth and subdued inflation. Brexit also constrains the Bank of England from normalizing rates.

Global Value of Negative Yielding Debt2

July 3,2019
$Trillions

chart

…About FIXED INCOME

Reasons to Be Cautious but Not Bearish

  • At the broadest asset allocation level, we are neutral on bonds.
  • Valuations appear full in many core markets. Term premiums are lowest among government bonds, with the global value of negative yielding debt reaching new peaks.
  • The economy is strong enough to be favorable for corporates, but individual issue selection and yield curve positioning are key.
  • We are in the latter stages of the US business cycle, so we believe that lightening exposure to lower rated sectors is prudent.
  • Be selective: Outside of developed markets, there are a subset of countries with strong economies that have shown resilience to global shocks, whose valuations are attractive to us.

Franklin Templeton Investments comprises multiple independent investment teams located around the world. As individual portfolio managers and teams pursue different fund mandates, there will always be different views held on the markets, and we consider that a strength. The insights above represent the current views of senior investment leaders and are subject to change.

Key Themes

ThemeRationale
Transformative Change
Creates Tremendous
Opportunity		 We believe advancements in digital experiences, artificial intelligence and distributed ledger technology are megatrend fintech catalysts that will reshape financial services. We expect the lines between financial services and big technology companies will continue to blur.

Biotechnology is entering the most transformative phase our analysts have seen in 25 years. New treatment paradigms, such as gene and cellular therapies, have jumped from laboratory to marketplace. Big pharma is morphing into biopharma as it acquires smaller biotech firms.
Volatility May Bounce Back
into the Picture		 Fundamentals continue to be positive, but a more cautious stance in equities may be warranted. The geopolitical environment may spark a resumption of the higher volatility seen late last year and revisited in May. Staying invested in the equity markets through funds with a history of more muted volatility, greater downside protection potential or tactical flexibility can be a route to consider. Greater divergence between strong and weak performers, and sector and country performers, has been accompanied by a rise in the volatility of investment style factors themselves.
Don’t Bail on Bonds—Choose
Wisely Instead		 While the global economy has pockets of slowing, likely exacerbated by political uncertainty, long-term valuations have remained expensive, reflecting low term premiums. Make sure your bond fund exposure has the potential to provide one or both of two benefits: 1) Returns non-correlated with the rest of your portfolio; 2) Yield commensurate with the duration risk. Active selection rather than broad market representation may provide what’s needed in a yield-constrained environment.
Seek Idiosyncratic
International Exposure		 Global conditions warrant selectivity rather than broad developed or emerging market exposure, as certain countries and sectors appear vulnerable. Emerging market valuations appear broadly attractive, and improving corporate governance is a structural driver for equity re-rating. Even within a country such as China, with its elevated risk, diligent research may separate many promising opportunities from the residual constituents included within an index.

1. Source: Morningstar. Based on the price moves in the S&P 500 Index from the close of market on the day prior to the comments to the close of market on the day following the comments, Jan. 4-7, June 4-5, and June 19-20.
2. Source: Bloomberg, 7/3/2019.

All investments involve risks, including the possible loss of principal.Special risks are associated with foreign investing, including currency fluctuations, economic instability and political developments. Investments in emerging markets involve heightened risks related to the same factors, inaddition to those associated with these markets’ smaller size, lesser liquidity and lack of established legal, political, business and social frameworks to support securities markets. Non-diversified funds that concentrate in the biotechnology sector involve risks such as patent considerations, product liability, government regulatory requirements, and regulatory approval for new drugs and medical products. Smaller, mid-sized and relatively new or unseasoned companies can be particularly sensitive to changing economic conditions, and their prospects for growth are less certain than those of larger, more established companies. Investments in fast-growing industries like the technology sector could result in increased price fluctuation.Bond prices generally move in the opposite direction of interest rates. As the prices of bonds in a fund adjust to a rise in interest rates, the fund’s share price may decline.

The comments, opinions and analyses expressed herein are for informational purposes only and should not be considered individual investment advice or recommendations to invest in any security or to adopt any investment strategy. The opinions and analyses are rendered as of 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.

Investors should carefully consider a fund's investment goals, risks, charges and expenses before investing. To obtain a summary prospectus and/or prospectus, which contains this and other information, talk to your financial advisor, call us at (800) DIAL BEN®/342-5236 or visit franklintempleton.com. Please read the prospectus carefully before you invest or send money.

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