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
We have improved our view on equities into July, despite signs of exuberance in some markets, as strong corporate fundamentals and healthy growth justify valuations.
Investor appetite for the artificial intelligence (AI) trade has concentrated equity index composition and caused some frothiness in technology stocks, but this appears to be contained, in our view. The broader equity market, notably in the United States, is supported by strong earnings and a resilient macro backdrop, while beneficiaries of AI capital expenditure (capex) continue to justify ambitious earnings growth expectations.
Material progress toward reopening the Strait of Hormuz has also significantly improved the outlook for equity markets in regions with a high sensitivity to energy prices.
Persistent inflation and hawkish policy rhetoric could challenge our view, though fiscal stimulus across many regions provides some offset.
Macro Themes
Steady growth
- Robust earnings expectations fuel an optimistic post-conflict outlook, supported by improving earnings breadth.
- The US economy has proven resilient, while labor-market data has stabilized.
- Leading economic indicators look healthy, but we are monitoring the impact of higher input costs.
Persistent inflation
- US inflation dynamics continue to be challenged by elevated core inflation, driven by services ex-housing.
- We expect limited second-order effects from the energy impulse, as conflict in Iran moves closer to a resolution.
- Core goods inflation is also above trend. Tariff pressures may have peaked but global supply chain tightness is currently providing an offset.
Policy bifurcation
- There is an increasing bifurcation between supportive fiscal policy and restrictive monetary policy as markets assess the energy price shock.
- The Middle East conflict has catalyzed a recalibration of policy expectations, with a tightening bias in most regions including the United States.
- Fiscal policy is supporting growth but contributing to expanding deficits. US tax refunds have been offsetting tariff headwinds, while energy support packages could also prove influential.
Portfolio Positioning Themes
Equity optimism
- Corporate fundamentals remain strong amid double-digit earnings growth expectations for the next 12 months.
- Conflict in the Middle East appears to be moving toward a resolution, and we would expect markets to look through any temporary setbacks.
- Positioning is showing signs of euphoria in some areas, but sentiment is neutral overall, remaining broadly supportive of risk assets.
Diversifying equity exposure
- We retain a preference for US large-cap equities, with a focus on the beneficiaries of AI capex. We also have diversified into value stocks amid concentration concerns.
- Reopening the Strait of Hormuz has improved our view of energy-sensitive markets in Japan and the euro area.
- We also favor emerging markets amid falling energy prices, healthy corporate fundamentals and exposure to AI capex beneficiaries.
Rebalancing duration
- We expect demand destruction to have a greater impact on monetary policy decisions than market pricing suggests, decreasing the chance that international central banks meet market hiking expectations.
- Resilient US growth and challenging inflation dynamics complicate Fed policy. We have moved further underweight US duration amid sustained upward pressure on yields.
- Excess returns for equities appear more attractive than credit, amid strong earnings and tight spreads.
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.
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