According to Franklin Templeton global stocks' performance may be better than global bonds
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In this Allocation Views, our Franklin Templeton Investment Solutions team believe growth momentum is decelerating, and the risks are skewed to the downside, accentuated by the impact of policy tightening and a squeeze on real incomes.
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The themes we discuss at our Annual Investment Symposium guide our research process. Over a longer-term horizon, we believe global stocks have greater performance potential than global bonds, despite slightly slower growth expectations. With interest rates starting from relatively elevated levels in developed markets, overall return expectations from all fixed income assets have become more attractive than has been the case in recent years.
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, should be the most likely path toward stable potential returns.
Major themes driving our views
Growth is slowing to below trend
Growth momentum is decelerating, and the risks are skewed to the downside, accentuated by the impact of policy tightening and a squeeze on real incomes. Leading indicators of growth suggest further weakness to come, even where current activity levels have held up reasonably well. Recession risks are meaningful and rising across developed economies.
A challenging inflation environment
Inflation remains well above targeted levels. Supply pressures have boosted inflation, but signs of a peak are in place despite the challenge of commodity shocks and the ongoing Russia-Ukraine war. These supply concerns are being balanced by demand destruction as the economic cycle slows.
Policy to remain restrictive
Most central banks have adopted a singular focus on inflation and are accepting the consequences for growth. Fiscal policy is responding to energy costs in some economies but will be slow to sway dovish in others. Expected central bank hikes will moderate negative real rates and sustain restrictive conditions.
Practical positioning
Nimble management still required
Having started to trim our allocation preference for equities at the start of this year, we retain a more cautious view of stocks. We continue to believe that a nimble investment style remains appropriate and have recently established an allocation preference away from equities. The levels of anticipated earnings per share remain close to their peak, which underplays concerns around economic growth.
Bond valuations have improved
Our longer-term analysis shows that the return potential from global bonds, including lower-risk government bonds, has improved. Once the current policy-tightening environment starts to moderate, it is likely that government bonds will again exhibit more of a risk-dampening effect. Until then, we believe bonds still make a more compelling case than they have for many years.
Opportunities in alternative assets
We are attracted to naturally diversifying “alternatives” such as private assets, which offer the potential to earn an incremental return linked to their relative illiquidity. These assets reflect trends in public markets, notably a higher risk-free rate environment. Private credit and private equity also include a healthy prospective return premium over public 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. 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.
