CONTRIBUTORS
Max Gokhman, CFA
Deputy Chief Investment Officer
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 and themes
Our approach to risk remains highly tactical moving into April, as conflict in the Middle East continues to drive markets.
Disruption of energy supplies is the main reason for tension in financial markets, and Iran retains the ability to impede energy production and transit regardless of US military dominance.
A complete resolution of hostilities is unlikely, in our view, despite the fragile ceasefire. As a result, we believe energy prices will remain elevated, feeding into inflation expectations, eroding private sector confidence and slowing economic growth.
Rising inflation makes it harder for central banks to stimulate sluggish economies, feeding the stagflation1 narrative and supporting a defensive approach to asset allocation.
Against this background, we have neutralized our cross-asset positioning in this month’s Allocation Views but still hold some risk within our intra-asset allocations.
Macro themes
Growth steady, but weakening
- Leading economic indicators have weakened somewhat, as business activity is crimped by higher input costs and waning confidence.
- Corporate sentiment appears strong, as evidenced by positive earnings revisions and guidance for calendar year 2026.
- The US economy has proven relatively robust, while labor market data is disparate but remains stable.
Persistent inflation pressures
- Inflation pressures were already increasing prior to the energy price shock, with most prints above central bank targets.
- Elevated energy prices may diminish real incomes and suppress demand, contributing to stagflationary conditions within major economies.
- Tariffs have been absorbed by both US consumer prices and business margins. As a result, core goods inflation remains above trend, albeit pressures may have peaked.
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 multiple hikes now priced in for most regions.
- Fiscal policy in major economies is generally supportive of growth. US tax refunds will likely offset tariff headwinds, while energy support packages could also prove influential.
Portfolio positioning themes
Tactically neutral
- Forecasting geopolitics is difficult and always requires a degree of humility. As a result, we strive to curtail the tracking error in our portfolios and reduce equity risk, as we await greater clarity.
- The macro backdrop has become more challenging, as inflation limits expectations for stimulative monetary policy.
- Sentiment and positioning have retreated to more attractive levels, supporting risk assets, while corporate fundamentals are relatively supportive.
Rotating toward core
- We have reassessed our US equity positioning, adding to core equities as the conditions for market breadth have weakened, amid a less attractive macro backdrop.
- We have trimmed our overweight allocation to Japanese and emerging market (EM) equities, given greater sensitivity to energy supply constraints caused by the Middle East conflict.
- We coordinate those changes with a reduction in underweight exposure to European and UK equities, as we strive to reduce tracking error.
Neutralizing government bonds
- We expect demand destruction to play a greater role in monetary policy decisions than inflation.
- Resilient US growth and sticky inflation make Federal Reserve (Fed) easing less likely, in our view. As a result, we stay underweight US duration.
- We have decreased exposure to EM local-currency bonds, taking a more cautious view of debt in this region amid ongoing uncertainty and US dollar strength.
Endnotes
- Stagflation: A combination of high inflation, elevated unemployment and stagnant growth.
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.
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