Reflections on Growing Economies and Fading Stimulus

2018 Global Investment Outlook

Templeton’s 2018 Views on Bargains, Value Catalysts and the Risks Dec 1, 2017

2018 Outlook: “Despite rising longer-term risks as the global equity bull market matures, we believe bottom-up opportunities remain evident.”

Conditions in global financial markets largely have remained benign heading toward 2018. In many countries, monetary policy is still easy, fiscal policy is becoming supportive, unemployment is falling, and economic growth is buoyant and synchronized globally. Additionally, inflation is generally subdued, corporate profits healthy and asset prices firm. In our experience, Newton’s first law of motion also applies to financial markets, and this global equity bull market seems likely to stay in motion until acted upon by a contrary force. As such, we think the current “Goldilocks” environment should remain a tailwind for stocks in 2018, absent an external shock.

What events might disrupt this rosy scenario? A sudden spike in inflation, a financial crisis in China, a conflict with North Korea, a resurgence of populism/extremism in Europe, or a policy error in the nascent monetary policy tightening cycle are some of the possibilities. While we can neither time nor predict the future, we can monitor indicators for potential signposts of an inflection point. To this end, near-term tactical indicators remained relatively subdued in late 2017, with little excess exuberance evident in consumer credit, corporate investment or wage inflation. Asset prices in broad terms have been elevated. Yet developed-market bond and equity valuations at 200-year highs (as of July 2017, according to at least one analysis) admittedly would be consistent with 200-year low interest rates. And with inflationary pressures generally dormant for now, we believe central banks have sufficient flexibility to respond to evolving financial conditions and begin normalizing monetary policy over time. Overall, the pitch and tenor of today’s global financial landscape seems more consistent with moderate reflation than unrestrained euphoria.

Turning Points and Opportunities

Nevertheless, inflection points in any cycle tend to be unpredictable and unexpected—and this isn’t just any cycle. The massive central bank stimulus required to recover from the 2007–2009 global financial crisis has led to extreme conditions that heighten systemic risk, in our view. Central bank balance sheets have ballooned to unprecedented sizes, creating an inorganic liquidity backstop, the removal of which could threaten elevated asset prices. Global sovereign debt levels and government budget deficits appear unusually high—conditions typically associated with periods of crisis and conflict, but now an everyday reality that we think increases the risk of, among other things, an unexpected spike in inflation. Finally, the rise of populism and nationalism, while apparently on the ebb for now, has increased geopolitical tensions and threatens to disrupt the fluidity of trade and labor that has contributed to globalization and prosperity.

Despite rising longer-term risks as the global equity bull market matures, we believe bottom-up opportunities remain evident. To this end, Europe is earlier in its cycle than the United States and has benefited from generally rebounding corporate profits, rising employment, and upticks in consumption and investment. Recent election results have favored pro-European, growth-oriented reformists, while the disarray associated with separatist movements in both Spain and the United Kingdom may deter schisms elsewhere. Against this backdrop, European stocks remained abundantly cheap relative to the rest of the world as of late 2017, according to our analysis. Asian opportunities have also been emerging, with Japan experiencing the longest bout of sustained growth since before the global financial crisis and South Korean companies making encouraging overtures toward better governance and shareholder rewards. In China, growth has been solid, currency reserves are once again on the rise, and stability appears to reign following the consolidation of power by President Xi Jinping in the recent 19th National Party Congress.

Our Sector Views: Health Care, Energy, Financials and More

From a sector standpoint, we continue to like health care, where we believe regulatory and competitive concerns have caused investors to lose focus on the long-term earnings power of disciplined, innovative and essential drug-makers. We believe select energy stocks still price in sub-US$50 per barrel oil and remain relatively attractive to us in what is likely to be a firmer—if potentially range-bound—pricing environment. Meanwhile, we’ve generally reduced some exposure to financials, though we believe bank valuations as of October 2017 remained undemanding and that the restructured and recapitalized industry should benefit from rising interest rates and improving credit demand. In our view, select opportunities also persist across a number of other sectors, including telecommunication services, information technology, consumer sectors and industrials.

We continue to find select investments we consider bottom-up bargains with asymmetric risk/return prospects, despite some evidence of overvaluation in certain regions and assets. We believe a renewed focus on value, which has pulled back again following a fledgling recovery in 2016, could be rewarded in 2018 as policymakers forge ahead with a new wave of reflationary fiscal stimulus and reform. Tailwinds from higher growth and rising inflation would, in our view, help cyclically depressed value stocks by improving pricing power and creating a healthier demand backdrop. We believe active management, in particular, has an important role to play at this stage in the cycle. In our view, the ability to spot secular business and product cycle trends, and identify stocks still trading at a discount to their long-term intrinsic value, will be instrumental in potentially maximizing total absolute return over the long term as the cycle matures and eventually inflects.

A Nascent Global Economic Recovery?
Several economic indicators show a strengthening global economy.

Global Trade Volumes and Global Purchasing Managers’ Indexes (PMIs)
January 1998–January 2018 (Estimate)

Global Trade (LHS)

PMI (RHS)

Recession Periods

Source: Minack Advisors, as of 10/31/17. Global manufacturing PMI, leading by three months. There is no assurance that any estimate will be realized.

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ADDITIONAL COMMENTARY

Michael Hasenstab, Ph.D.

Global Macro

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Christopher J. Molumphy, CFA

Fixed Income

Constructive but Cautious for 2018

Ed Perks

Multi-Asset

Optimism and Selectivity in 2018