What Franklin Templeton Thinks...

Q1 2020

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

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What Franklin Templeton Thinks

…About THE ECONOMY

Our 2020 Outlook Sees Uncertainty but No Looming Recession

  • We see few signs the global economy is headed toward recession, although slowing global growth remains a concern.
  • The United States—the world’s largest economy—remains on steady footing despite persistent trade uncertainty.
  • Many of the world’s leading economies face significant monetary, fiscal and economic policy concerns due to potentially slowing growth.
  • The slowdown in global trade may be showing signs of stabilization; but while US-China trade negotiations have concluded a phase one, the situation remains unresolved.
  • Uncertainty may persist throughout the year, but we see significant opportunities as well.

…About GLOBAL EQUITIES

Modest Caution Prevails

  • We believe that with economic growth likely to continue and monetary policy supporting growth, global equities can remain appealing in 2020.
  • In Europe ex-UK, economic activity has slowed due to global trade concerns and weaker manufacturing activity, but our views reflect the market discounting these conditions.
  • In the UK, the equity market is historically cheap. The short-term political uncertainty has eased, there is pent up corporate demand, and consumption is supported by wage growth outpacing inflation.

…About US EQUITIES

Nimble Management May Be Required Amid Volatility

  • US growth remains stronger than in other developed markets.
  • The market’s attention will likely focus on valuations, margin pressure and whether the Fed rate cuts actually boost growth.
  • We think the US economy can continue to grow in a range of 2-3% annually for much longer than many believe.
  • Bottom-up stock selection is needed, focusing on companies innovating within their respective industries, and in out-of-favor value stocks.
  • Recurring market selloffs may occur due to elections and trade issues.

…About EMERGING MARKETS

Upside Potential Has Appeal; Global Growth Uncertainty Weighs

  • Emerging market growth is forecast by the IMF to accelerate in 2020 and be more than double that of developed markets.
  • EM equities have been trading below their long-term average discount to developed markets despite improving cash flows and dividend payout ratios, and corporate deleveraging.
  • Selectivity by country and security is particularly important.

…About ACTIVE MANAGEMENT

More Than at Any Time in the Recent Past, Selectivity Is Key

  • The valuation gap between cheap and expensive stocks has become the widest it’s been since 2000. Value has lagged growth significantly twice before—in the 1930s, and in the 1990s run up to the dot com bubble bust. Differentiating real growth from liquidity fueled run ups may be critical.

    Value vs. Growth 10-Year Annualized Excess Total Return1
    January 31, 1985 -December 31, 2019 (MSCI World Value Index -MSCI World Growth Index)

    chart
  • Stretched valuations in fixed income amid the chase for yield requires selectivity in terms of sectors and underlying securities.
  • The range of starting points of emerging market economies, and the various forms of populism occurring in those countries, create a dispersion of potential outcomes from which active managers can benefit.

…About INTEREST RATES

Beware Central Bank Mission Creep

  • We expect the US Fed funds rate to be kept on hold through at least the first half of 2020.
  • Recently, we have seen signs of significant mission creep from major central banks, with several openly stating a desire to “extend the cycle.”
  • Reasons range from further increasing economic growth to reducing income inequality to fighting climate change. But all aim to justify continuing an extremely loose policy stance.
  • We think greater politicization of monetary policy is a problem because:
    • Central banks don’t have enough tools to meet all these targets.
    • It has contributed to asset valuations becoming stretched across most sectors---essentially trading reduced volatility today for an unknown quantity of volatility at some point in the future.

…About FIXED INCOME

Select Opportunities Are Available

  • The investment grade sector remains supported by strong corporate fundamentals, but leverage is high and technical conditions may prove challenging. Some widening of spreads appears likely as growth slows and financial conditions tighten.
  • Loose monetary policy has exacerbated market distortions, making perceived safe-haven fixed income assets exceedingly expensive.
  • Default rates in high yield appear to be rising to historical averages.
  • Select opportunities in asset-backed and mortgage-backed securities are available.

Key Themes

ThemeRationale
New Year’s Revolution:
INNOVATION IS GENERATIONAL
We strongly believe innovation drives long-term wealth creation. Consider five innovation themes likely to shape the “Fourth Industrial Revolution”: Global E-Commerce, Genetics Breakthroughs, Intelligent Machines, New Finance, and Exponential Data. Regardless of short-term economic conditions, these platforms are likely to have a major impact on how we live in 10 years.
New Year’s Resolutions:
GET ACTIVE Active management may be worth considering in select areas of portfolios as the economic expansion continues into its 11th year. Funds with Active Share in excess of 90% may help differentiate from index-driven results.
WORK THE CORE The US equity market appears unlikely to deliver the same results as in 2019, but it still may be the best game in town. Given the somewhat higher than historical valuations of the indexes, prudence may warrant finding approaches that seek to avoid lower quality companies and lessen volatility.
IMPROVE FLEXIBILITY Nimble management of portfolios may be required if volatility picks up this year. Funds offering flexible mandates may be able to capitalize on the opportunities that volatility presents.
LOSE (EXCESS RISK)
WEIGHT
Lower volatility strategies in fixed income may help investors in managing overall portfolio fluctuations without going to cash. Municipal bonds offer investors diversification advantages that could prove beneficial during periods of late-cycle market volatility. Active management supported by robust credit research in an asset class that sports a low correlation to equity returns may help sort valuable from vulnerable ahead of any market downturn.
TRAVEL MORE While international equity markets may not appear as favorable overall, their valuations reflect lower expectations. A focused exploration of select opportunities could prove rewarding. Emerging markets offer greater potential, especially over the long-term, while short-term volatility throughout developed markets may have a knock-on effect. In fixed income, select global markets and currencies offer better potential value than many traditional bond sources.