Global Investment Outlook from Franklin Templeton
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Fixed income deserves a good deal of attention—delivering income is back.
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Diversification and income may be enough motivation to move some holdings further out the US yield curve.
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Equities should benefit from a taming of inflation and earnings optimism.
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Following consecutive quarters of falling US corporate profits, the outlook for earnings is beginning to brighten.
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A US recession remains the overwhelming consensus view and hence is to some extent already accounted for in market prices—it is likely to come later and be shallower than its predecessors.
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Our risk worry list includes deep recession, geopolitical tensions, energy shocks and soggy returns.
As investors look towards the second half of 2023 Franklin Templeton says the mid-year outlook showcases the ongoing theme around the attractiveness of investments beyond cash including fixed income, equities and alternatives.
Stephen Dover, chief market strategist at the Franklin Templeton Institute says, “If 2022 was a year when nothing went right for investors, then the first half of 2023 flipped the script. Despite a series of mishaps over the past six months—ranging from falling corporate profits, to some of the largest bank failures in US history, to an overwhelming consensus predicting recession—stocks and bonds each staged strong rebounds in the first half of this year. After a miserable 2022, the classic 60%–40% mix of US stocks and bonds etched a 6% gain in the first six months of 2023.
“Does that portend a weak second half? Will the familiar adage, “sell in May and go away” prove prescient for the final two quarters of 2023? We don’t think so, and we don’t subscribe to selling in May—or June or July for that matter.
“Nor do we think returns will be soggy; that is a risk, but not our base case. Rather, we believe the second half of 2023 offers opportunities for investors to get cash off the sidelines. There will be challenges, and a vertical bull market is hardly our view.
“But the opportunities on offer—near and longer term—point to a simple conclusion It is time to engage more fully,” says Dover.
Also read: Why You Should Consider Liquid Infrastructure Credit
The Franklin Templeton investment team highlights the following potential investment opportunities:
1. Time to engage more fully—Many investors have understandably parked cash in money market funds yielding over 5%; we believe it is also opportune to move some holdings further out the US yield curve. The prospect of peak policy rates, further declines in US inflation and some slowing of growth are apt to push long-term yields lower over the second half of the year, boosting returns on safe, longer-duration fixed income holdings. As we point out below, taking duration risk also typically improves portfolio diversification.
2. Investment-grade credit—The highest-quality areas of the credit market have become more attractive, providing higher yields in investment-grade bonds relative to the dividends from equities.
3. Generally high-quality, short duration—When broadly looking at higher-quality credit, the default risk premiums are sufficiently attractive to compensate investors, even with some probable slowing of economic activity. Accordingly, within credit markets, we broadly prefer
higher-quality, shorter-duration holdings.
4. Selected long-duration bonds—The case for higher-quality, long-duration bonds has improved as a likely peak in interest rates arrives sooner rather than later. A decline in rates could provide more capital appreciation to the more interest-rate sensitive longer-duration Treasuries, as well as selected corporate bonds trading at discounts to par.
5. High-quality high yield—However, high-yield bonds with stronger ratings profiles due to better fundamentals look to be a potential total return opportunity. Particularly when compared to equities, high-yield debt has a shorter duration profile than other parts of the fixed income market, while at the same time providing equity-like total return potential.
6. Emerging market debt—Another opportunity, which we also noted at the beginning of this year, exists in emerging market local currency debt. Attractive yields (double-digit in some cases) coupled with US dollar weakness, offer an opportunity to enjoy equity-like returns, but without the degree of downgrade or default risk we see in US high-yield credit markets.
7. US equities—Looking beneath the surface, bifurcated earnings streams may be creating new patterns of return dispersion. Share prices are responding to earnings outcomes in different ways across sectors and styles. The disparity in returns may increase as earnings variability could be a key factor behind finding “winners and losers.”
8. Non-US equities—We believe it’s prudent to consider opening or establishing larger positions in non-US markets. We understand the reluctance. After a decade of massive US equity outperformance (since 2013, cumulative 20% versus Japan’s Nikkei, over 70% versus the German DAX, and nearly 150% versus the UK FTSE), US investors are rightfully sceptical of taking their portfolios overseas. But over the past six months, the Nikkei has doubled the S&P 500’s 7% return, and the German DAX has trumped it by three full percentage points. It is happening because of more attractive valuations and because of superior earnings upgrades, which we expect will continue.
9. Historic opportunity in private credit—With rates still elevated relative to recent history, private credit will likely pick up a larger share of the loan market from regional banks. Given these dynamics, private credit managers will have the ability to more easily negotiate favorable pricing, terms and covenants.
“With this hint of stability, second-half opportunities arrive in almost too many places, including alternatives,” they note.
