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
Preview
We retain our cautiously optimistic view of equities into December, despite recent market volatility, leaning into a foundation of solid macro and corporate fundamentals.
Global growth appears healthy, measured by positive leading indicators of economic momentum, and economic activity has also been trending in the right direction. There is some variance globally, but the data has been broadly supportive of risk assets. Elsewhere, the disinflation trend remains in place despite difficulty pushing inflation down through the final mile to target levels.
Labor-market weakness and tariff uncertainty warrant close monitoring, but they are not of sufficient concern to shake our “risk-on” conviction. Additionally, we believe that concerns about an artificial intelligence (AI) bubble are premature and symptomatic of erroneous comparisons with the “dot-com” bubble of the early 2000s.
Against this background, in this month’s Allocation Views, we retain an overweight to equities, balanced by an underweight to fixed income. Sticky inflation and rising fiscal deficits add upward pressure to long-term government bond yields, while alternatives continue to add diversification and hedging opportunities.
Macro themes
A resilient growth story
- Leading economic indicators remain resilient, fueled by AI capital expenditure (capex) and high-end consumers.
- Diminished tail-risk from tariffs has supported corporate sentiment and earnings, evidenced by positive third-quarter reporting and guidance.
- The US economy has proven robust, but we continue to monitor labor-market data, which has softened from a strong position but not collapsed.
Balanced inflation outlook
- Inflation sits above central-bank targets in most developed economies and is likely to remain complicated through the end of this year, due to tariff pressures.
- US companies are currently absorbing tariff-induced inflation pressures by tightening margins. We expect an additional impact on core goods inflation as businesses pass price increases to consumers.
- Services inflation has eased due to lower housing costs and wages, helping counteract other pressures.
Policy leans supportive
- Limited data visibility may prevent the Federal Reserve (Fed) from cutting interest rates in the near term, but we expect further easing during the next 12 months.
- Having said that, we still think the magnitude of easing that markets expect is too optimistic, given a robust economy and complicated inflation dynamics.
- Fiscal policy in major economies is an increasingly influential driver of asset prices. US tax refunds will likely offset tariff headwinds, while stimulus measures in Japan and Germany could also prove supportive.
Portfolio positioning themes
Responsibly bullish
- Equity market momentum is supported by positive earnings revisions and guidance, which outweigh valuation concerns, in our view.
- Leading and current indicators of economic strength remain positive and support risk assets, as does purchasing managers’ index (PMI) data.
- Sentiment levels have deteriorated during the recent equity market retracement. We think this is positive for risk assets and helps offset valuation concerns.
Emerging equity opportunities
- We retain our optimistic view of US large-cap stocks relative to small-caps and regional equities. Robust earnings and a supportive macro backdrop guide our thinking.
- Earnings expectations are rising rapidly across emerging markets (EMs) ex-China, influencing our more constructive view on the region. Macro conditions are also supportive.
- We have become more pessimistic toward international developed market equities amid weak earnings growth forecasts and a weaker macro backdrop.
Underweight government bonds
- We believe longer-term market expectations for Fed policy easing are too optimistic. Elsewhere, central bank rhetoric has become more hawkish recently.
- Fiscal deficits are widening in major economies, as governments increase spending or cut taxes to stimulate growth. Consequent yield effects make us selective on duration.
- Tight spreads diminish the risk-adjusted returns available from credit. Earnings growth leads us to favor equities.
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.
WF: 7712410