Still Looking on the Bright Side

In this Allocation Views, our Franklin Templeton Investment Solutions team believe global stocks still have greater performance potential than global bonds, reflecting only slightly slower growth expectations.

    Ed Perks, CFA

    Ed Perks, CFA Chief Investment Officer,Franklin Templeton Investment Solutions

    Gene Podkaminer, CFA

    Gene Podkaminer, CFA Head of Multi-Asset Research Strategies,Chair of Investment Strategy & Research Committee,Franklin Templeton Investment Solutions

    PREVIEW

    The themes we discuss at our Annual Investment Symposium guide our research process. Over a longer-term horizon, we believe global stocks still have greater performance potential than global bonds, reflecting only slightly slower growth expectations. With interest rates starting from relatively low levels in developed markets, overall return expectations from all fixed income assets remain relatively low, which would drag down asset returns generally.

    We recognize that our longer-term outlook will not be reached along a smooth path and 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.

    MAJOR THEMES DRIVING OUR VIEWS

    • Continued strong, but slowing, global growth
      A period of above-trend global expansion is anticipated through next year, although this may be largely built into investors’ expectations. Consumers in developed economies remain in a strong financial position. Regional divergences will be accentuated by access to vaccines and the persistence of policy accommodation.
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    • High inflation is largely temporary, but risks remain elevated
      Global inflation has exceeded consensus expectations, pulled higher by demand for goods. Ongoing supply bottlenecks are boosting headline inflation, but they should ease in the first half of 2022. In the longer term, secular disinflationary forces, such as technology and globalization, remain strong.

    • Supportive policy despite incremental tightening
      Central bank rates are likely to remain low or negative in real terms. Although central banks are transitioning away from crisis measures, tapering asset purchases and delivering selective rate hikes, global liquidity keeps flowing. Additionally, fiscal objectives contribute to a dovish bias to policy and a more stable outlook, even where geopolitical risks are highest.


    PRACTICAL POSITIONING

    • Nimble management still required
      We continue to see stronger medium-term return potential for stocks than bonds and believe that they should earn their equity risk premium over time. Our equity preference remains more modest than in the past, as markets largely reflect strong economic data. We continue to believe that navigating the challenges presented in the months ahead will require nimble management.

    • Bond valuations remain stretched
      Our longer-term analysis shows that the return potential from global bonds, especially government bonds, remains depressed. But low yields likely reflect demographics and demand for matching assets, which are likely to persist. However, strong growth supports the fundamental attractions of lower-rated fixed income sectors such as high-yield bonds and loans.

    • Opportunities in alternative assets
      When looking for alternative assets that might offset “risk-on” exposure to stocks and corporate credit, we are attracted to real assets. The anticipated return from alternative assets remains modest in comparison to stocks, and it is largely for their risk-reducing characteristics that they justify a place in a longer-term portfolio, in our view.


    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. The positioning of a specific portfolio may differ from the information presented herein due to various factors, including, but not limited to, allocations from the core portfolio and specific investment objectives, guidelines, strategy and restrictions of a portfolio. There is no assurance any forecast, projection or estimate will be realized. Stock prices fluctuate, sometimes rapidly and dramatically, due to factors affecting individual companies, particular industries or sectors, or general market conditions. Bond prices generally move in the opposite direction of interest rates. Thus, as the prices of bonds in an investment portfolio adjust to a rise in interest rates, the value of the portfolio may decline. Special risks are associated with foreign investing, including currency fluctuations, economic instability and political developments. Investments in emerging markets, of which frontier markets are a subset, involve heightened risks related to the same factors, in addition to those associated with these markets’ smaller size, lesser liquidity and lack of established legal, political, business and social frameworks to support securities markets. Because these frameworks are typically even less developed in frontier markets, as well as various factors including the increased potential for extreme price volatility, illiquidity, trade barriers and exchange controls, the risks associated with emerging markets are magnified in frontier markets. Derivatives, including currency management strategies, involve costs and can create economic leverage in a portfolio which may result in significant volatility and cause the portfolio to participate in losses (as well as enable gains) on an amount that exceeds the portfolio’s initial investment. A strategy may not achieve the anticipated benefits, and may realize losses, when a counterparty fails to perform as promised. Currency rates may fluctuate significantly over short periods of time and can reduce returns. Investing in the natural resources sector involves special risks, including increased susceptibility to adverse economic and regulatory developments affecting the sector—prices of such securities can be volatile, particularly over the short term. Investment in the commercial real estate sector, including in multifamily, involves special risks, such as declines in the value of real estate and increased susceptibility to adverse economic or regulatory developments affecting the sector.