CONTRIBUTORS
Brett Goldstein, CFA
Head of Multi-Asset
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
We remain optimistic toward equities into August, as we look through renewed geopolitical tensions and inflation concerns to focus on strong corporate earnings.
In addition, recent equity market volatility has reset valuations for technology names and moderated sentiment and positioning indicators that were trending toward exuberance.
The overarching macro picture remains broadly neutral, despite the dampening effect further interest-rate rises could have. This isn’t enough to fuel our optimistic view of equities alone, but, crucially, it does nothing to counter the persuasive “risk-on” argument offered by very strong corporate fundamentals.
We retain an artificial intelligence (AI) tilt within our portfolios with overweight exposure to US, Japan and emerging market (EM) equities. We are generally less optimistic toward markets with lower exposure to AI and technology, particularly those with sensitivity to energy and commodity prices.
We continue to see international duration as relatively attractive. Weaker macroeconomic outlooks outside the United States raise the likelihood that market expectations for interest-rate rises are too optimistic in those regions.
Macro Themes
Strong Growth
- Macro growth remains strong, supported by strong corporate earnings power.
- The US economy has proven especially resilient, while labor-market data has stabilized.
- Leading economic indicators look healthy, but we are monitoring the impact of higher input costs.
Complex inflation
- Elevated core inflation continues to challenge US inflation dynamics, although recent data has been more positive.
- We expect limited second-order effects from the energy impulse, as supply-driven inflation will reduce real incomes and suppress consumer spending.
- Core goods inflation is also currently above trend. Tariff pressures may have waned, but we are monitoring global supply-chain tightness.
Tighter Monetary Policy
- Heightened tensions in the Middle East have catalyzed a recalibration of policy expectations, with a tightening bias in all major regions, including the United States.
- Fed Chair Warsh’s new approach is creating additional uncertainty. We ultimately believe the Fed will need to tighten monetary policy.
- Fiscal policy is supporting growth but contributing to expanding deficits. Defense spending and energy support packages could also prove influential.
Portfolio Positioning Themes
Cross Asset: Risk-On
- Corporate fundamentals remain strong amid double-digit earnings growth expectations for the next 12 months.
- Macro growth remains constructive but is offset by a tougher inflation and policy backdrop.
- Sentiment and positioning have become less stretched, supporting equities, but remain volatile in narrow segments such as AI.
Equity Diversification
- Our equity exposure is tilted toward AI, reflected as overweight exposure to the US, EMs and Japan. Positioning has eased and creates a more constructive setup moving forward.
- Euro-area growth indicators have improved, but energy sensitivity limits our optimism for European equities.
- Australian equities remain our least-preferred region due to a mixture of weak domestic growth, unsupportive fiscal policies and tight monetary policy.
Neutral Duration
- We expect demand destruction to have a greater impact on monetary policy decisions than market pricing suggests, decreasing the chance that international central banks meet market hiking expectations.
- Resilient US growth and elevated inflation complicate Fed policy. We improve our view of US Treasuries amid rising yields but maintain a relative preference for international duration.
- Excess returns for equities appear more attractive than credit, amid strong earnings and tight spreads.
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.
Any companies and/or case studies referenced herein are used solely for illustrative purposes; any investment may or may not be currently held by any portfolio advised by Franklin Templeton. The information provided is not a recommendation or individual investment advice for any particular security, strategy, or investment product and is not an indication of the trading intent of any Franklin Templeton managed portfolio.
WF: 11707660