Inflation, Rotation and Opportunities

In this global investment outlook, our investment professionals across asset classes share how they’re thinking about portfolios amid continued market uncertainty.

    INTRODUCTION

    Our outlook draws on our wide range of independent investment managers to deliver asset class insights. Each manager approaches the economic environment with a different lens and offers views to help inform your decision making.

    As we look forward to the post-COVID-19 pandemic period, we see predictions of above-average economic growth globally, unprecedented fiscal and monetary economic stimulus, and increased likelihood of inflation. We are entering an economic environment never seen before. Broadly, the common themes from our managers are:

    • Given the return to growth in global economies, we are more “risk on” generally.
    • While the extended low interest-rate environment looks likely to continue, there are risks of inflation and rising interest rates.
    • Fixed income should remain vital, in our view, with high yield and bank loan instruments potentially offering lower sensitivity to rising interest rates.
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    • While equity investments offer an opportunity to add to performance, equity valuations are stretched by historical valuation standards. Our managers think opportunities still exist, particularly in companies on the cutting-edge of change that stand to benefit from the economic expansion and from resilience in emerging markets, especially in Asia.
    • We believe there’s significant opportunity in emerging markets today, particularly in Asia, but geopolitical risks bear watching.
    • Alternative asset investments such as hedge funds and commercial real estate may provide diversification, some protection for volatile interest rates and inflation, and may offer a partial substitute for a portion of fixed income.
    • Environmental, social and governance (ESG) awareness is increasingly vital for risk-management and for potentially better expected returns.

    Several of our investment professionals discuss the implications across asset classes. They share how they are thinking about their strategies considering continued market uncertainty, whether the extended low interest-rate environment will continue, and where they see potential opportunities.

    Stephen Dover, CFA
    Chief Market Strategist,
    Franklin Templeton Investment Institute

    FIXED INCOME MAY PLAY AS VITAL A ROLE AS EVER

    Western Asset
    Given today’s extended low interest-rate environment, along with elevated levels of uncertainty—not just around COVID-19, but also regarding US-China trade, Brexit and Middle East tensions—fixed income may play as vital a role as ever in investors’ portfolios. We expect global central banks to remain extraordinarily accommodative, especially given ongoing subdued inflation pressures, fragile global growth and the persistence of downside risks.

    Glenn Voyles, Franklin Templeton Fixed Income
    We believe credit selection will be more important than ever in 2021 given that investor behavior in the current environment has led to some mispricing of risk. Overall, we have a positive view on the high-yield asset class given continued improving fundamentals and valuations that have further room to run.

    EQUITY MARKETS CONTINUE TO OFFER OPPORTUNITIES

    Aram Green, ClearBridge Investments
    We believe growth investing will be more challenged than in the recent past, when the fastest growing/highest multiple stocks outperformed by a wide margin. These companies now need to deliver on the promises implied in their rich valuations—and many won’t achieve that. That’s why active management is as crucial as ever.

    Matthew Moberg, Franklin Equity Group
    Recently, we’ve seen some shifts in market leadership toward value-oriented and cyclical names in the wake of the pandemic nearing an end. Even with these shifts, we continue to see opportunities across many high-growth companies and believe the discounted cash flow methodology is the best way to determine a company’s intrinsic value.

    Manraj Sekhon, Franklin Templeton Emerging Markets Equity
    From the height of the pandemic through the current early stage of recovery, our conviction in the growing structural advantages of emerging markets, led by key Asian economies, has only strengthened as the evidence has accumulated. Emerging markets have remained relatively resilient, having successfully adapted to, or suppressed, the virus.

    ALTERNATIVES HELP DIVERSIFY

    Brooks Ritchey, K2 Advisors
    Hedged strategies typically have performed well in both rising and falling interest-rate environments. In particular, these strategies help to diversify one’s portfolio in a rising rate environment given the resultant increase in performance dispersion across regions, sectors and asset classes. We believe these strategies are particularly interesting now as a fixed income diversifier given the potential for renewed economic growth and an uptick in inflation.

    Tim Wang, Clarion Partners
    Looking forward, we are quite optimistic about real estate’s growth prospects in 2021–2022 because of the fast US vaccination rollout, additional fiscal stimulus and robust consumer demand. Real estate is a derivative of economic expansion, and all property sectors are likely to benefit from the pent-up demand and forthcoming jobs boom. Higher interest rates often link to better economic growth, which should lead to stronger demand for commercial space and higher income growth, offsetting the potential negative impact on financing costs.

    ALL INVESTING WILL EVENTUALLY BE ESG INVESTING

    Mary Jane McQuillen, ClearBridge Investments
    Stocks with strong environmental sustainability profiles generally performed well in 2020 as a result of a variety of trends. We consider some of these to be secular trends that should support ESG sustainability-focused investments for the longer term, such as helping fight climate change by lowering carbon emissions or overcoming resource scarcity through use of recycled materials. We believe that all investing will eventually be ESG investing, that one day it will no longer be considered a separate discipline.



    Global Investment Outlook allows the Franklin Templeton Investment Institute strategists to highlight manager’s views on markets across the firm. The mission of the Investment Institute is to deliver research-driven insights, expert views and industry-leading events for clients and investors globally through the diverse expertise of our autonomous investment groups, select academic partners and our unique global footprint.

    Two related Franklin Templeton Thinks publications of note are Allocation Views, produced by Franklin Templeton Investment Solutions, which offers you our best thinking on multi-asset portfolio construction; and, Macro Perspectives, produced by the Investment Institute, featuring economist from across the firm dissecting key macroeconomic themes driving markets

    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. Bond prices generally move in the opposite direction of interest rates. Thus, as the prices of bonds adjust to a rise in interest rates, the share price may decline. Investments in foreign securities involve special risks including currency fluctuations, economic instability and political developments. China may be subject to considerable degrees of economic, political and social instability. Investments in securities of Chinese issuers involve risks that are specific to China, including certain legal, regulatory, political and economic risks. High yields reflect the higher credit risk associated with these lower-rated securities and, in some cases, the lower market prices for these instruments. Interest rate movements may affect the share price and yield. Treasuries, if held to maturity, offer a fixed rate of return and fixed principal value; their interest payments and principal are guaranteed. Stock prices fluctuate, sometimes rapidly and dramatically, due to factors affecting individual companies, particular industries or sectors, or general market conditions. Investments in emerging market countries 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. Such investments could experience significant price volatility in any given year. Investments in fast-growing industries like the technology sector (which historically has been volatile) could result in increased price fluctuation, especially over the short term, due to the rapid pace of product change and development and changes in government regulation of companies emphasizing scientific or technological advancement or regulatory approval for new drugs and medical instruments. Biotechnology companies often are small and/or relatively new. Smaller companies can be particularly sensitive to changes in economic conditions and have less certain growth prospects than larger, more established companies and can be volatile, especially over the short term. Impact investing and/or Environmental, Social and Governance (ESG) managers may take into consideration factors beyond traditional financial information to select securities, which could result in relative investment performance deviating from other strategies or broad market benchmarks, depending on whether such sectors or investments are in or out of favor in the market. Further, ESG strategies may rely on certain values-based criteria to eliminate exposures found in similar strategies or broad market benchmarks, which could also result in relative investment performance deviating. 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. Investments in infrastructure-related securities involve special risks, such as high interest costs, high leverage and increased susceptibility to adverse economic or regulatory developments affecting the sector. Actively managed strategies could experience losses if the investment manager’s judgement about markets, interest rates or the attractiveness, relative values, liquidity or potential appreciation of particular investments made for a portfolio, proves to be incorrect. There can be no guarantee that an investment manager’s investment techniques or decisions will produce the desired results. Investments in alternative investment strategies and hedge funds (collectively, “alternative investments”) are complex and speculative investments, entail significant risk and should not be considered a complete investment program. Financial derivative instruments are often used in alternative investment strategies and involve costs and can create economic leverage in the fund’s portfolio which may result in significant volatility and cause the fund to participate in losses (as well as gains) in an amount that significantly exceeds the fund’s initial investment. Depending on the product invested in, an investment in alternative Investments may provide for only limited liquidity and is suitable only for persons who can afford to lose the entire amount of their investment. There can be no assurance that the investment strategies employed by K2 or the managers of the investment entities selected by K2 will be successful. The identification of attractive investment opportunities is difficult and involves a significant degree of uncertainty. Returns generated from alternative investments may not adequately compensate investors for the business and financial risks assumed. An investment in alternative investments is subject to those market risks common to entities investing in all types of securities, including market volatility. Also, certain trading techniques employed by alternative investments, such as leverage and hedging, may increase the adverse impact to which an investment portfolio may be subject. Depending on the structure of the product invested, alternative investments may not be required to provide investors with periodic pricing or valuation and there may be a lack of transparency as to the underlying assets. Investing in alternative investments may also involve tax consequences and a prospective investor should consult with a tax advisor before investing. In addition to direct asset-based fees and expenses, certain Alternative Investments such as funds of hedge funds incur additional indirect fees, expenses and asset-based compensation of investment funds in which these alternative investments invest. Diversification does not guarantee profits or protect against risk of loss. Companies and/or case studies shown herein are used solely for illustrative purposes; any investment may or may not be currently held by any portfolio advised by Franklin Templeton.