Allocation Views

Growth momentum in the global economy is improving.

Franklin Templeton Multi-Asset Solutions


Last month in Allocation Views, we wrote about financial markets becoming inured to the publication of data that had been shockingly weak. Indeed, the level of uncertainty about the path toward economic recovery might go some way to explain why some extraordinary data was ignored. As the sharp fall in activity caused by COVID-19 lockdowns is reversed, will markets similarly ignore startlingly good news? At this stage, they seem to be doing so. Measures of economic surprises in the United States have swung from historic lows to all-time-highs in less than two months (see Exhibit 1 in PDF). At the same time, US equities have started to lose momentum and Treasury bond yields have not risen.

In contrast, European fundamentals have done little more than stabilize at low levels as we examine similar economic data. However, on two other measures, corners may have been turned. As we discussed last month, the European Union is showing greater unity in its response to the current slowdown. Investors remain aware of the challenges that lie ahead, but policymakers seem to be making progress in agreeing on a coordinated stimulus package. We share the sense of cautious optimism that the “Next Generation EU”1 plan might be a game-changing moment. The relative strength of European equity markets in June serves as evidence of an
easing of investor concerns. We have moved to increase our conviction in European government bonds as we share this growing confidence. This is driven by the improved outlook for higher-yielding markets, such as Italy, that stand to benefit from the recovery fund.

The other area where Europe and Asia seem to be turning the corner is in the suppression of the coronavirus itself. Levels of new infection have moderated in many countries, allowing further steps along the road toward reopening of economies. We remain alert to the risks of a second wave of infections later in the year, but expect that localized or partial closures might contain them. In contrast, the Americas seem to be struggling to contain the first wave of infections, with both Brazil and the United States reporting record levels of new cases. For now, these developments are being met by modest adjustments to business activity and little more than concerned glances by many equity investors. Helped by the heavy weighting of technology stocks, the US NASDAQ equity index remained near new all-time highs at June-end. We retain a somewhat more constructive view of US stocks but have moderated the level of our conviction, given the extent of recent gains and ongoing headwinds to local and global growth.

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What Are the Risks?

All investments involve risks, including possible loss of principal. 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. Diversification does not guarantee profit or protect against risk of loss. 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.