CONTRIBUTORS
Brett Goldstein, CFA
Head of Multi-Asset
Franklin Templeton Investment Solutions
Tom Nelson, CFA, CAIA
Head of Market Strategy
Franklin Templeton Investment Solutions
Miles Sampson, CFA
Head of Asset Allocation Research,
Franklin Templeton Investment Solutions
Summary
Robust growth and underlying corporate fundamentals support a continuation of our “risk-on” approach, despite recent market volatility driven by concerns about rich valuations for global technology stocks.
Besides solid fundamentals, our analysis of artificial intelligence (AI) demand shows consistent adoption, despite concerns around financing and commoditization. This research supports an AI tilt within our equity portfolios, with a preference for the United States, emerging markets (EMs) and Japan.
Inflation remains a primary driver of bond markets and has influenced our fixed income positioning moving into November. A reflationary environment in the United States means we have curtailed our optimism toward US Treasuries, as we see greater relative value in international bonds issued by countries with weaker macro backdrops, such as the United Kingdom and Canada.
Macro Themes
Strong Growth
- Macro growth remains strong, supported by resilient corporate earnings power.
- The US economy has proven especially resilient. Estimates of US growth are above-trend, while the labor market appears stable.
- Leading economic indicators and business activity appear healthy, but we are monitoring the impact of higher rates and input costs.
Inflation Uncertainty
- The US inflation picture remains challenged by a prolonged period of elevated core readings. Recent sticky data supports this view.
- We expect limited second-order effects from the energy impulse, as supply-driven inflation reduces real incomes and suppresses consumer spending.
- Core goods inflation remains a concern. Tariff pressures have waned, but we are monitoring global supply chain tightness.
Tighter Monetary Policy
- Heightened tensions in the Middle East continue to influence a recalibration of policy expectations, with a tightening bias in all major regions, including the United States.
- The market now expects a more hawkish Federal Open Market Committee (FOMC) as the US Federal Reserve (Fed) focuses on reinforcing its credibility.
- US midterm elections should have little impact on fiscal policy or bond yields, although debates on budgets and the debt ceiling may cause some volatility in bond markets.
Portfolio Themes
Cross-Asset: Risk-On
- Corporate fundamentals remain strong amid double-digit earnings growth expectations for the next 12 months.
- Macro growth remains constructive but is offset by a complicated inflation and policy backdrop.
- Sentiment and positioning have become more supportive amid equity market volatility, particularly around AI-sensitive themes.
Equity Diversification
- Our equity exposure is tilted toward artificial intelligence (AI), reflected in overweight exposure to the United States, emerging markets ex-China (EMs), and Japan.
- Optimism around US earnings breadth is confined to large-cap stocks, as higher interest rates disproportionately affect small-cap earnings.
- Australian equities remain our least-preferred region due to a mixture of weak domestic growth, unsupportive fiscal policies and tight monetary policy.
Value in Duration
- We expect higher energy prices to weigh on demand, potentially reducing the likelihood that major central banks raise rates as much as markets currently anticipate over the next year.
- We hold a relative preference for international bonds, downgrading our view of US Treasuries amid a reflationary macro backdrop.
- We believe equities may offer more attractive relative return potential than credit, supported by strong earnings expectations. Heavy AI-related issuance is also pushing yields higher, crowding out lower-quality issuers.
WHAT ARE THE RISKS?
All investments involve risks, including possible loss of principal.
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. Changes in the credit rating of a bond, or in the credit rating or financial strength of a bond’s issuer, insurer or guarantor, may affect the bond’s value. Low-rated, high-yield bonds are subject to greater price volatility, illiquidity and possibility of default.
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.
Commodity-related investments are subject to additional risks such as commodity index volatility, investor speculation, interest rates, weather, tax and regulatory developments.
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.
Investing in privately held companies presents certain challenges and involves incremental risks as opposed to investments in public companies, such as dealing with the lack of available information about these companies as well as their general lack of liquidity.
Active management does not ensure gains or protect against market declines. Diversification does not guarantee a profit or protect against a loss.
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.