CONTRIBUTORS
Wylie Tollette, CFA
Chief Investment Officer,
Franklin Templeton Investment Solutions
Tom Nelson, CFA, CAIA
Head of Market Strategy
Franklin Templeton Investment Solutions
Max Gokhman, CFA
Head of MosaiQ Investment Strategy,
Franklin Templeton Investment Solutions
Miles Sampson, CFA
Head of Asset Allocation Research,
Franklin Templeton Investment Solutions
Preview
Every year we review the data that drive capital markets—current valuation measures, historical risk premia, economic growth and inflation prospects—to provide the foundation for our forecasts. We update the models that we use and review their continued appropriateness. Crucially, our models are based on first-principle economic relationships and reflect seasoned practitioner judgment.
We continue to include as part of every capital market forecast a measure of the expected volatility of that asset class, informed by long-term observed standard deviation of returns. Given that changes to global central banks’ quantitative easing policies may have repressed both equity and bond market volatility over past years, but increased turbulence more recently, our approach to modeling volatility reduces recency bias and is particularly appropriate at a time when many leading central banks have moved to normalized policy.
Our capital market expectations (CMEs) are designed to provide annualized return expectations over a longer-term horizon, typically viewed as 10 years. Specifically, we calculate geometric mean return expectations over a 10-year period, which both fully captures the average length of a US business cycle and aligns with the strategic planning horizon of many institutional investors.1
Our modeling approach is based on a blend of objective inputs, quantitative analysis and fundamental research, consistent with the skill set of our Franklin Templeton Investment Solutions (FTIS) business. Underpinning these inputs are assumptions on the sustained growth rates that developed and emerging economies can expect to achieve and the level of price inflation they will likely experience. This approach is forward-looking, rather than being based on historical average returns. This is especially important in an evolving macroeconomic environment.
Summary
We believe riskier assets, such as global stocks and corporate bonds, have greater performance potential than global government bonds, despite slightly slower global growth and supported by a marginal decline in global inflation expectations.
- We believe that maintaining a diversified portfolio of risk premia, in addition to the traditional benefits of a balanced portfolio between stocks and bonds, is the most likely path toward stable potential returns.
- With global interest rates starting from elevated levels and expected to normalize, overall return expectations from all fixed income assets have become significantly more attractive to us than has been the case in recent years, and notably higher than we anticipated in our 2023 CME forecasts.
- The risk premium contained within corporate bond yields has tightened but appears to be adequate compensation for the likely level of default risk across the business cycle.
- Earnings growth and yield will likely drive equity returns, with minor support from some valuation uplift. We no longer expect margins to be a headwind over our 10-year horizon.
- Over the 10-year horizon used for our CMEs, we see relatively healthy alternative risk premia and a constructive environment for asset returns.
- We expect the US dollar to depreciate versus most currencies as our valuation metrics suggest it is overvalued.
- Since 1945, the National Bureau of Economic Research has defined 12 US business cycles, with an average duration of 75 months.
WHAT ARE THE RISKS?
All investments involve risks, including possible loss of principal. The value of investments can go down as well as up, and investors may not get back the full amount invested.
Equity securities are subject to price fluctuation and possible loss of principal.
Fixed income securities involve interest rate, credit, inflation and reinvestment risks, and possible loss of principal. As interest rates rise, the value of fixed income securities falls.
To the extent the fund invests in alternative strategies, it may be exposed to potentially significant fluctuations in value.
The allocation of assets among different strategies, asset classes and investments may not prove beneficial or produce the desired results. To the extent a strategy invests in companies in a specific country or region, it may experience greater volatility than a strategy that is more broadly diversified geographically.
International investments are subject to special risks, including currency fluctuations and social, economic and political uncertainties, which could increase volatility. These risks are magnified in emerging markets. The government’s participation in the economy is still high and, therefore, investments in China will be subject to larger regulatory risk levels compared to many other countries.
Currency management strategies could result in losses to the fund if currencies do not perform as expected.
Active management does not ensure gains or protect against market declines.
Any companies and/or case studies referenced herein are used solely for illustrative purposes; any investment may or may not be currently held by any portfolio advised by Franklin Templeton. The information provided is not a recommendation or individual investment advice for any particular security, strategy, or investment product and is not an indication of the trading intent of any Franklin Templeton managed portfolio.