“Going forward, we expect significant convergence in relative growth rates after a long period of US exceptionalism. Global investors are structurally overweight US dollar (USD)-denominated assets, and we believe there are both economic and geopolitical reasons for reducing these exposures over time. However, a further selloff in the USD may require definitive evidence of a deterioration in US economic growth.

“Meanwhile, there are multiple crosscurrents affecting the US bond market, which are currently balancing each other out. On one hand, the US economy is gradually slowing down. On the other hand, additional US fiscal easing at a time when the government debt level is already high is pushing bond yields upward.

“Despite a reprieve in tariffs, the trade war is far from over. We expect tariff rates to eventually settle at meaningfully higher levels than before the Trump administration took office. Tariffs lead to higher inflation and slower economic growth. Faced with stagflationary risks, the Federal Reserve (Fed) is likely to be cautious in reducing policy rates.

“Even though short-term recession risks have diminished, we expect US growth to slow significantly in the second half of the year. This deceleration is due to the tax-like impact of tariffs along with trade policy uncertainty also depressing investment and hiring. Federal workforce layoffs, lower immigration, and a decline in international tourism may contribute additional drags on economic activity. What is unclear is whether the weakness in growth will be significant enough to trigger a more aggressive Fed policy easing cycle amid elevated short-term inflation risks. At the same time, the eurozone economy will be supported by the significant monetary easing delivered over the past 12 months and the massive multi-year German fiscal stimulus package.”

On the outlook for global equities, Sorin Roibu, Portfolio Manager and Research Analyst said, “The global equity landscape is experiencing a fundamental shift as the era of US market dominance faces mounting challenges. With first quarter gross domestic product (GDP) turning negative and trade policy uncertainty weighing on growth prospects, the US economy appears increasingly vulnerable to stagflationary pressures from tariff-driven inflation and constrained Federal Reserve policy. This environment is driving what we call the “Great Expectations Reversal,” a strategic pivot away from overvalued US markets toward undervalued international opportunities.

“The US faces multiple headwinds: shaky consumer confidence, heightened trade uncertainty, and a challenging handoff from government to private sector leadership. While labor markets remain resilient, downside risks are increasing. Equity markets continue to shrug off these growing warning signs, with US market valuation levels back to historic highs.

“Europe is emerging as the standout destination, bolstered by German fiscal stimulus, attractive valuations, and resilient labor markets. European banks have already delivered exceptional returns, with some gaining 35% to 45% year to date.

“Within emerging markets, Brazil presents compelling opportunities with strong fundamentals and solid economic performance. Meanwhile, China offers selective prospects, particularly in companies benefiting from AI.

“With US market capitalisation-to-GDP ratios reaching levels last seen in 1929 and 1936, the risk-reward dynamic increasingly favours international diversification. We believe investors should consider reducing US exposure while capitalising on the fundamental strength emerging across global markets.”

Emerging Markets expert, Carol Lye, Portfolio Manager, Senior Research Analyst added, “Despite elevated uncertainty, emerging markets (EM) have performed well this year. Local currency markets are up over roughly 10%, and hard currency sovereigns and corporates have returned just over 4% and 3%, respectively, for the year to date. In local markets, currencies have contributed a little over 50% of the return, and we believe there is still room for further appreciation. The US dollar remains elevated from a valuation perspective, and the world is overweight dollar-denominated assets following years of outperformance. Some rebalancing out of the dollar and into undervalued or overlooked markets could benefit EM.

“From a regional standpoint, Latin America offers elevated nominal and real yields. We will be following the heavy election calendar for signs of shift to more centrist candidates, which could reinforce investor confidence and act as a catalyst for the region. Central European markets are well positioned to benefit from a departure from Europe’s recent economic stagnation, especially if fiscal stimulus and targeted industrial policy gain traction.

“A more aggressive trade rebalancing coupled with the cyclical and structural dynamics that are underway may expand opportunities in other EM. Some of these markets may be well positioned to benefit from a secular shift in global production and capital flows. US policy aimed at curbing state-subsidised overcapacity may accelerate the relocation of supply chains toward other markets, including EM economies. This trend could invigorate investment opportunities in infrastructure, local manufacturing, and upstream commodities across Asia, Latin America, and Africa.”

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Felicity Walsh

Brandywine Global, a specialist investment manager of Franklin Templeton, is pleased to announce the receipt of a ‘Recommended’ rating by Zenith for the Brandywine Global Opportunistic Equity Fund (GOE).

Zenith Investment Partners is a leading investment research and managed account provider, with a 20-year track record of delivering premium investment research, fund ratings and investment portfolio solutions for financial advisers.

“This ‘Recommended’ rating from Zenith follows on from Lonsec’s Recommended rating in May and is further proof of the investment management team’s capabilities in this space,” Felicity Walsh, Managing Director Franklin Templeton Australia said.

“Launched earlier this year, this fund expands Franklin Templeton Australia’s suite of global equity strategies, catering to investors seeking differentiated active opportunities. The strategy leverages top-down macroeconomic insights to complement comprehensive fundamental value driven bottom-up research and we are delighted to see Zenith acknowledge the success of this approach,” she added.

In its report, Zenith said it believes the fund is well-managed by an experienced investment team, that adopts a differentiated investment approach combining macroeconomic and fundamental analysis.

The Global Opportunistic Equity team is led by James J. Clarke and Sorin Roibu, CFA, who are responsible for managing the fund, and who have been involved in the management of the strategy since 2013 and 2014 respectively.

“Zenith believes the portfolio managers have built a strong long-term partnership, underpinned by their complementary expertise and experience,” the report said.

“The team is bolstered by Brandywine’s Global Macroeconomic Research team of over 30 members. Given that the investment process relies heavily on macro insights and views, Zenith believes this resource provides great benefits to the GOE team,” the report stated.

The Brandywine Global Opportunistic Equity Fund invests in 60 to 100 global companies, limiting stock position size to five per cent at purchase, and aims to outperform the MSCI ACWI and/or Russell Global Index.

“We note that the portfolio managers have demonstrated a strong long-term track record through multiple market cycles, which underpins our confidence in the investment strategy,” Zenith said.

The investment team identifies investment themes through detailed research and, given Brandywine’s value-biased investment process, assessing the downside risks to individual stocks takes on even greater significance.

Co-Portfolio Manager and Director of Fundamental Equity Research, James Clark added, “Our investment process seeks ‘multiple ways to win’ through macro, market assessment and stock selection, which has generated highly differentiated outcomes relative to peers. We believe value as a style will deliver in the long run, and we see extremely attractive valuations in what we currently own with many stocks held trading at 8-10 times earnings.”

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Felicity Walsh

Leading research house, Lonsec Research has awarded Brandywine Global’s Opportunistic Equity Fund an inaugural ‘Recommended’ rating, indicating the research agency has strong conviction the product can meet its investment objectives.

“This is the fund’s first rating since its launch in Australia just last month and we are delighted to receive this recognition from local ratings agency Lonsec,” Felicity Walsh, Managing Director, Franklin Templeton Australia said.

“This is an important milestone for the strategy and to have Lonsec’s rating at this stage of our launch is testament to the strength of the investment process that has been in place for over 10 years,” Walsh added.

In its report, Lonsec highlighted several key strengths of the manager’s investment process. “The rating reflects the well-experienced portfolio management team and their ability to leverage its internally generated stock research,” said Lonsec.

The firm also earned praise for its “well-established and coherent macroeconomic research process” – a cornerstone of Brandywine Global’s approach. By seamlessly integrating their robust macro analysis with comprehensive bottom-up company evaluation, the manager demonstrates a skill for identifying attractive investment opportunities across the capital markets.

The Brandywine Global Opportunistic Equity Fund invests in in 60 to 100 global companies, limiting stock position size to 5 per cent at purchase, and aims to outperform the MSCI ACWI (in AUD).

Lonsec was impressed with the experience of both portfolio manager and director of fundamental research James Clarke, and portfolio manager and research analyst Sorin Roibu.

“Specifically, Clarke and Roibu have comparable level of experience relative to other fundamental value peers, with both individuals having access to an adequate analyst capability with whom they have collaborated for a prolonged period of time,” Lonsec noted.

Brandywine Global’s distinct investment approach combines top-down macroeconomic analysis with rigorous bottom-up fundamental research to identify undervalued companies. The strength of their investment process is evidenced by an impressive 10+ year track record managing global equities. Of particular interest has been the team’s ability to generate consistently strong returns in an environment where growth stocks have continued to outperform, all while staying true to the value philosophy.

“The manager’s scale and heritage as a global asset manager focused on value strategies provides further support,” Lonsec said.

Lonsec commended the manager’s overall ESG policy framework and disclosure which were aligned with peers.

“ESG has always been an important part of our process and we are pleased that Lonsec recognises this too,” Brandywine Global portfolio manager and research analyst Sorin Roibu said.

According to Roibu “Brandywine Global takes its commitment to social responsibility seriously, and the Fund has a number of sustainability screens in place.”

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Felicity Walsh

Brandywine Global, a specialist investment manager of Franklin Templeton and well-regarded in Australia for its fixed income capabilities, has announced the expansion of its suite of products with the launch of Brandywine Global Opportunistic Equity Fund for Australian investors.

“We are delighted to be able to launch this Fund in the Australian market as we believe there is a high demand for strong global value equity strategies such as ours,” Brandywine Global Investment Director Richard Rauch said.

Felicity Walsh, Managing Director, Franklin Templeton Australia said “The new Fund expands Franklin Templeton Australia’s suite of global equity strategies, catering to investors seeking differentiated active opportunities. Investors realise that having a more diversified global focus across their portfolios is not just about returns, but about managing risks and market volatility.

“Brandywine Global is well recognised in the Australian market for its global fixed income strategies. This Fund extends Brandywine Global’s capabilities for Australian investors, utilising the same analytical rigour and fundamental value framework along with the macroeconomic analysis for which the firm is well known,” said Walsh.

The Fund invests in 60 to 100 global companies, limiting stock position size to 5 percent at purchase, and aims to outperform the MSCI ACWI Index.

“We have a 10+ year track record in managing global equites where we leverage top-down macroeconomic insights to complement our comprehensive fundamental value-driven bottom-up research. Unlike traditional value strategies, our distinct investment process is premised on the philosophy that valuation alone is not a catalyst. The Fund’s approach helps us to avoid value traps and style drift while enhancing the strategy’s ability to capture diversified sources of return – through what we call ‘multiple ways to win,” Brandywine Global Portfolio Manager Sorin Roibu said.

“We use our macroeconomic insights to provide direction and bottom-up fundamental equity research to identify undervalued companies. On a micro level, we look for companies with solid balance sheets and strong free cash flow, favouring sectors believed to be well positioned to capitalise on key macro catalysts,” Roibu said.

“Stocks in the portfolio span a diverse mix of sectors and industries. We are generally invested in larger-cap stocks and our risk metrics are aligned with our view that opportunities are not plentiful in the current environment. As always, we are vigilant and awaiting new opportunities. Market shifts can happen very quickly, and we are prepared to act opportunistically should investor fear arise in the U.S. or elsewhere in the world,” Roibu said.

Brandywine Global also takes its commitment to social responsibility seriously, and the Fund has a number of sustainability screens in place.

Since 1986, Brandywine Global has provided a range of differentiated fixed income, equity, and alternative solutions to clients worldwide. Brandywine Global, a specialist investment manager of Franklin Resources, Inc., manages US$60 billion in assets under management as of 31 March 2024, with headquarters in Philadelphia and offices in Singapore and London.

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Francis Scotland

Brandywine Global, part of Franklin Templeton, presents a more optimistic view on inflation in its latest macroeconomic update.

Francis A. Scotland, Director of Global Macro Research at Brandywine Global says “The financial and monetary variables point to a positive direction. Inflation is the final piece in a falling line of dominoes. What went up in 2020 and 2021—cryptocurrency, commodities, real estate, economic growth, and inflation—have retreated in perfect sequence starting late 2021 and early 2022. Now it is inflation’s turn.

“We believe keeping conditions tight until inflation has receded to target is a strategy for overshooting the objective and moving straight to deflation. A lot of lip service—but perhaps not enough credence—is given to the notion of policy lags. What the Fed implements today affects the economy months or years later. The retreat in inflation seen since June of last year has little to do with Fed policy, in our view. The reaction to what the Fed has done or is going to do is yet to come.”

He says the world is out of sync on many other issues.

“The Fed wants things to slow; China’s leaders want things to pick up; the European Central Bank’s (ECB’s) monetary vise already has the economy in a technical recession, but it must do more because of stubbornly higher inflation; and in select emerging countries policy is even more stringent than in the U.S., judging by yield curves.

“This divergence explains why global growth is uneven and argues for much reduced inflation. China’s reopening has fizzled due to feeble domestic consumption. Nothing could be more crystal clear about the state of domestic demand in China than its inflation data.

“According to the latest data from China’s National Bureau of Statistics, core CPI is close to zero, producer prices are falling, and China is exporting its deflation to the rest of the world. Efforts to reflate the system with public policy are compromised by a number of factors. China’s augmented budget deficit is probably already over 10%, based off an April 2022 report by the Institute of International Finance. The authorities do not want to boost leverage, nor do they want to fire up property speculation.

“However, the priorities of President Xi Jinping are the biggest impediments to rebooting China. Under his leadership, anti-corruption, national security, oversight of private companies, property speculation, and the stability of the Chinese Communist Party have taken priority over economic growth. President Xi did a U-turn on COVID containment late last year and elevated growth as a priority in the wake of public protests. But the follow-through has been tepid.

“ECB rate hikes have already led to a technical recession, but it seems likely to worsen because of the economic zone’s stubbornly high inflation rate. Europe’s monetary profile is horrible, in my view; banks are not lending—annual growth in lending to both households and businesses dropped close to zero in April, according to the ECB.

“Bank lending is much more important in Europe than the U.S. and accounts for the majority of financial intermediation. The poor lending data rhymes with the June production manager surveys, showing a generalised contraction in European manufacturing. Meanwhile, the non-manufacturing survey is barely holding above 50. One reason for the stubborn nature of inflation is fiscal policy. Roughly 800 billion euros in fiscal support have been provided to EU business and households to help offset energy costs,” says Scotland.

In this scenario, we are bullish bonds across our portfolios through investments in Treasury bonds, mortgage-backed securities (MBS) bonds, and select emerging market bonds, adds Scotland.

He says “The biggest pricing anomaly in the fixed income markets is the U.S. yield curve, more extremely negative than at any time in modern history except for the early 1980s. Yield curves in some emerging countries are even more inverted. We believe the risk/reward profile warrants long duration positioning. Everything mentioned earlier points to a bull steepener in the yield curve.

“A Fed-provoked recession could trigger a bond rally; our base case of falling inflation and a mild economic downturn would also support the bond market but with less upside.

“There is some near-term risk to the upside in yields if the Fed continues to raise rates and nominal GDP growth remains strong a while longer. However, history shows GDP itself is a poor early warning indicator of a sudden drop-off in activity, the data generally remaining firm right up to the moment it weakens.

“On the currency front, I believe the U.S. dollar is overvalued based on most metrics but not in the extreme. In addition, tight monetary policy and expansionary fiscal policy is typically constructive for a currency, which is the current policy backdrop in the U.S. Consequently, our foreign currency allocations out of dollars are on a selective bilateral case-by-case basis. Companies have not been complaining about the strength of the dollar despite wider current account and trade deficits. Similarly, the dollar has not responded much to Treasury Secretary Yellen’s admission that Americans should expect a decline in the greenback as the world’s reserve currency as China, Russia, and some other prominent countries look for ways to dethrone it and escape potential U.S. sanctions.

“The reality is that no other major economy has the depth of capital markets, the institutional infrastructure, and the laws that could replace dollar hegemony for now. It is hard to picture what will provoke a meaningful retreat in the dollar this year given the Fed’s determination to restore low inflation, not to mention the darkening outlook in Europe.

“Expectations that the euro could rally because the Wagner rebellion in Russia might hasten an end to the war seem a bit optimistic given that Putin has no history of retreat, only escalation. The threat of confrontation with NATO in the event of Russia using nuclear weapons or blowing up the Zaporizhzhia nuclear power plant suggests that there are tail risks at least in both directions.

“Nor does China’s desire to support its economy seem overly bullish for the renminbi or, therefore, overly bearish for the dollar. Longer-term U.S. fiscal degradation could lead to massive tax increases, which would be very negative for the currency. The only positive in that equation is that most of the Western world is in the same boat,” says Scotland.

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Richard Rauch, Investment Director at Brandywine Global says: “We were expecting disinflation to start to take hold as we move through 2023. This was a favorable print in terms of the Fed getting toward its terminal rate – we still think the Fed hikes in July despite lower-than-expected CPI.

“We want to be mindful that this is but one data print, with volatile series like airfares surprising to the downside. Stepping away, shelter inflation is still a strong contributor to CPI, but we expect shelter inflation to continue in a downtrend into the end of the year. Used vehicles also experienced disinflation.

“Inflation has fallen a lot in the US, now for 12 consecutive months after peaking over 9% a year ago. Optimism that it will keep falling is what has supported risk assets. We think it is going to keep falling, too. But the decision-makers at the Fed are not convinced. Their job is to keep inflation on target. They believe policy rates and the unemployment rate need to go higher in order to push inflation back to target.

“The Fed might be right but the justification for its viewpoint is mainly the inflation rate itself and the low level of unemployment. This stance implies no change in view or policy until after inflation has fallen, as was the case after inflation rose. And it is not just the Fed. Its perspective is the orthodoxy these days among western central bankers and high-profile economic commentators: higher for longer on rates.”

Rauch adds “Brandywine Global’s view on inflation is more optimistic because:

• The financial and monetary variables point in that direction.
• Inflation is the final piece in a falling line of dominoes. What went up in 2020 and 2021—cryptocurrency, commodities, real estate, economic growth, and inflation—have retreated in perfect sequence starting late 2021 and early 2022. Now it is inflation’s turn.
• We believe keeping conditions tight until inflation has receded to target is a strategy for overshooting the objective and moving straight to deflation. A lot of lip service—but perhaps not enough credence—is given to the notion of policy lags. What the Fed implements today affects the economy months or years later.
• The retreat in inflation seen since June of last year has little to do with Fed policy, in our view. The reaction to what the Fed has done or is going to do is yet to come.”

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J. Patrick Bradley, Senior Vice President – Investment Research at Brandywine Global, part of Franklin Templeton says: “On the other side of the coin, there is a sizable contingent who still assert that a soft landing remains possible.

“I am not in that camp. The exact timing of when a potential recession might begin is lacking, but a fledgling U.S. banking crisis may have shortened the timetable. Let us look at where we are in the business cycle and see if there are any recessionary signals.

“Most likely, in my view, a recession is baked in now.  The U.S. has just experienced three regional bank failures. The failures of Silicon Valley Bank and Signature Bank saw a surge in discount window borrowing. Next, First Republic Bank became the latest bank to fail, earning the dubious distinction of being the second-largest bank failure in U.S. history. Now, other struggling banks, hoping to avoid the same fate, are actively seeking suitors. This turmoil and uncertainty will ripple through the economy just as the steadfast tightening of U.S. monetary policy is also manifesting in financial conditions.

“Some experts may believe the banking crisis is over, following the purchase of First Republic’s assets and deposits by JP Morgan. I am less reassured. The Fed appears to be staying the course on its rate-hiking path, putting banks and other interest-rate sensitive sectors under further strain. These potent ingredients of the Fed’s earlier hikes and recent bank failures suggest recession is likely baked into the mix.

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European bank stocks are also attractive, but we would be selective in which banks to invest.

Brandywine Global, part of the Franklin Templeton, notes this was a banking crisis that Europe hoped to avoid even as panic spread from the US.

“Still, we believe the global banking sector remains much safer,” says Sorin Roibu, Portfolio Manager and Research Analyst at Brandywine Global.

Roibu says: “The recent banking industry events in the US and Europe have brought back memories of the 2008 global financial crisis (GFC). In the span of just over one week, two banks failed in the US while another remains on life support, and one bank failed in Europe. For the week ending March 10, the top six US large money center banks lost approximately 14% in market value; US super-regionals lost around 26% in value; and smaller regionals lost over 30% in market value. European banks lost 12% in market value for the same period, according to FactSet research.

“This crisis was not supposed to happen. After all, banks today are significantly better capitalised than they were going into the GFC. Risky exposures also have come down significantly and some, like subprime mortgages, have been essentially eliminated. Every year, banks undergo rigorous stress tests that model their businesses through severely adverse economic scenarios, and banks generally pass with flying colours. So, what went wrong? And do we see further risks to the outlook for the banking sector or opportunities in the aftermath? There are plenty of similarities among bank crises, but each one is a little different. It is especially important to understand the differences.”

“The first domino fell in an area that was never thought of as a significant risk: an investment portfolio comprised of Treasury bonds and government-backed securities, which by definition are assumed to carry no credit risk. They do, however, carry interest rate risk. Most of the time this risk is not a big deal, unless we see a significant rise in rates as we did in 2022 into this year. The Federal Reserve’s aggressive tightening cycle caused significant mark-to-market losses on these securities. These are paper losses that over time will mature at par, resulting in recovery of the mark-to-market loss. The caveat here is that losses become real if the bank must liquidate the portfolio. In addition to unrealised losses on the banks’ available-for-sale (AFS) and held-to-maturity (HTM) portfolios, the failed institutions also had other idiosyncratic risks. The first bank failure exposed a significant number of uninsured deposits, deposits in excess of the $250 thousand FDIC insurance limit. Company filings for Silicon Valley Bank showed approximately 88% of total deposits at year end 2022 were uninsured.1

“Further concerns about concentrated bank clientele, either limited to specific sectors or narrow geographic regions, also emerged, putting smaller US regional banks under pressure. As nervous depositors looked to withdraw uninsured accounts, a perfect storm emerged. The banks had to liquidate portfolio securities at current bond prices, taking big losses, which reduced the banks’ liquidity. Mounting losses resulted in a panic among depositors, who all rushed for the door. The result was a textbook definition of a run on the bank.

“Loss of confidence and liquidity shortages are the common killers of banks. History suggests that once a bank run starts, it is hard to contain and can spread to other banks. There is a self-fulfilling nature to bank panics, and as we saw over the past few weeks, in this digital age they can spiral rapidly.

“The panic spread quickly to the European banks, pushing a long-ailing financial institution over the cliff. To be clear, this failure and arranged sale to a rival had nothing to do with the problems at US banks and more to do with mismanagement over the past decade. We believe this failure was going to happen sooner or later; the recent crisis of confidence just sped up the process.

“Despite the selloff in European bank shares, we see little similarity between the drivers of the US and European banking crises. In fact, for the first time in a long time, European banks’ liquidity situation appears in better shape than that of their US counterparts. Post-GFC, European bank regulators introduced liquidity requirements to hold banks to standards aimed at ensuring lenders could survive substantial stressed liquidity outflows. In the US, large-cap banks, those with assets above $250bn, also known as Systemically Important Financial Institutions (SIFI), have similar liquidity requirements in place. However, in 2018, the US regulators rescinded some of the requirements for banks with assets under $250bn, including some of the short-term liquidity requirements. This is where the problem started, and where, we believe, it will remain contained.

“Despite the current fears in the marketplace, we believe that the global banking sector remains much safer than it has been in the past. Most importantly, the regulatory toolkit has evolved and allows regulators to address these crises quickly and more effectively.

“In other words, we believe this situation shall pass and with minimal risk of escalation and contagion like we saw during the financial crisis of 2008.”

He adds: “In the US: In response to what happened, we expect bank regulation in the US will likely increase with greater emphasis on small and mid-size regional banks. We also expect the earning power for smaller regional banks to decrease due to rising funding costs.

“In Europe: Meanwhile, we expect the European bank woes to be limited to one specific case. Not only do we feel the risks in Europe are largely idiosyncratic, but we see several characteristics that distinguish the European banking sector from that of the US, which should keep broad contagion at bay:

“European banks generally hold more cash, and securities comprise a smaller portion of balance sheets for these banks. Therefore, European banks have not had to sell securities at a loss to meet liquidity needs. The European Central Bank (ECB) maintains established facilities to provide liquidity, which can be accessed quickly by banks. European banks’ lending and deposits were more constrained post-pandemic, and they did not grow as rapidly as in the US.

“Once investors realise that the current situation is not a repeat of the 2008 GFC, we think confidence will be restored, and banks can return to business as usual.

“Given our bearish outlook for the US economy and the US dollar, we generally remain more constructive on global equities. We see growth in China, with its recent reopening, continuing to recover post-pandemic, which should shift relative growth away from the US. Furthermore, we expect the European economy to fare better than the US economy on a relative basis, which should also be positive for European banks.

“The US market remains our biggest underweight, and our exposure here skews more defensive. Among US banks, we prefer the large, money center banks. These banks have much stronger deposit franchises than their regional peers. In fact, they have been the beneficiaries and recipients of deposit flight from smaller banks. These banks are also considered safer and carry an extra regulatory burden to prevent failure, unlike banks with $250bn in assets or less, which are not subject to the same standards and rigorous oversight requirements.

“European bank stocks are also attractive, but we would be selective in which banks to invest. There is a wide difference between the quality of banks, as we have recently witnessed in Switzerland and in Germany over the past couple of years. There are also regional macro differences that carry implications for earnings of banks exposed to those respective countries. We prefer a select number of banks, predominantly in France and Spain, which have high-quality management and diversified business exposures.”

———

Endnotes:
Source: Barr, A. “Silicon Valley Bank is a particularly scary failure. Here’s why.” Business Insider. March 10, 2023.

Definitions:
Mark-to-market (MTM) is a method of measuring the fair value of accounts that can fluctuate over time, such as assets and liabilities. Mark to market aims to provide a realistic appraisal of an institution’s or company’s current financial situation based on current market conditions.

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“But there are other external factors worth discussing for the impact they could have on the world’s major economies,” notes Jack P. McIntyre, Portfolio Manager, Brandywine Global.

“The first one is inventory levels. Over the last couple of years, we’ve seen an overall decline in the growth rate of inventories. Last year it was about uncertainty over U.S.-China trade. This year, it’s about uncertainty over how the pandemic is going to play out. Given that level of uncertainty, nobody is eager to build out a huge amount of capital and inventory right now. This is a global phenomenon – we’re seeing low inventories across the board. We see it, for example, in the recent figures for U.S. as well as Chinese auto inventories.

“The point here is that when we start to see less uncertainty and the global economy gets a little better footing, investment in inventory could be a source of additional growth, benefiting both the developing world and developed world.

“Another potentially external positive influence is housing, a huge driver of the U.S. domestic economy.  We look at the combination of the year-over-year change in mortgage rates and the year-over-year change in unleaded gasoline prices.  These two key variables clearly influence economic behavior in the U.S. In the case of gasoline, it influences consumption. In the case of mortgage rates, it influences housing.

“Right now, we’ve seen significant declines in both gasoline prices and in mortgage rates. So far, the shift in mortgage rates has had a bigger impact. They have come down significantly, and housing is really starting to see signs of recovery and is back to punching above its weight.

“On the gasoline side of things, things are taking a little longer to unfold. Initially, the big decline in oil prices led to a significant pullback in CapEx in the U.S. around the energy industry. Energy has become a huge part of the US economy, so that’s meaningful. But the decline in gasoline prices ultimately more than compensates for that negative impact. When I add these two together, given where we are today, it should actually be a net positive for consumption in the U.S. around gasoline prices, and housing should continue to see improvement based on still very low mortgage rates.

“On top of all this, there are high cash balances across all aspects of the economy around the globe, reflecting high levels of uncertainty. We expect that as we see uncertainty diminish, some of this cash will be put to work — a net positive for the underlying economy and also for markets.

“Not surprisingly, fund managers appear to be holding more cash as well. It’s important to note that there’s nobody on this planet who has been managing money in the kind of pandemic environment that we’re experiencing now. Still, the fiscal and monetary response has chipped away at the uncertainty, and I think that that’s sort of winning the war right now, and should be the catalyst to get some of this cash to be put to work,” he says.

The post The post-COVID economic factors that merit investor consideration appeared first on AdviserVoice.

In a recent research note, J. Patrick Bradley, Senior Vice President, Investment Research at Brandywine Global ( part of Legg Mason ) states: “There’s nothing prophetic about saying the coronavirus will change the way we live and conduct business. Unemployment will rise, and some of that increase will create permanent joblessness. Some businesses will fail, despite the efforts of monetary authorities and governments to replace the income lost and to stem the spread of the virus. We have to wonder whether or not governments will come under pressure from citizens straining under the lockdown, who have lost jobs, and have found it increasingly difficult to feed their families.”

He investigates various themes to conclude:

• The coronavirus pandemic does not preordain the onset of social unrest, but it can create a fertile environment for social unrest;
• Countries at risk would be those with the weakest healthcare capacity; and,
• In the end, how governments address the crisis and the subsistence needs of its citizens will determine how susceptible a country is to civil unrest and even changes in governments.

No conclusion is too far-fetched

Many parts of the world have been under mandated lockdowns and the services sector has been especially hard hit, like restaurants and tourism. Only essential services have been permitted to operate. This has led to protests across the globe…tensions are rising.

Chart 1: Stringency Index

Source: Oxford COVID-19 Government Response Tracker. ^[1]

Indexes are unmanaged, and not available for direct investment. Index returns do not include fees or sales charges. This information is provided for illustrative purposes only and does not reflect the performance of an actual investment.

In most developed countries, the strength of their institutions will allow a peaceful resolution to the lockdown dissents. However, the same peaceful resolution of conflict in emerging markets (EMs) may be different, where the strength and stability of institutions and government responses to the virus crisis might prevent a resolution of protests or civil disorder. Chart 1 shows the stringency index, a measure of governmental responses to the crisis, including school closings, fiscal stimulus, and healthcare. Arguably, a higher stringency score would be an indication of aggressive country measures to stem the spread of the virus. In this chart, Peru shows the most aggressive policies, while New Zealand has the lowest—the latter has begun to slowly exit its lockdown. Aggressive policies, particularly in EMs, could contribute to social unrest and growing protests, which could exert a negative impact on a country’s economy.

Protests have arisen as a response to government policies that locked down their economies. India and Iran are just two countries where citizens have reacted. In India, migrant workers staged protests. Thus far, police in many emerging countries have been able to restrict the protests. However, as incomes are hit and workers face unemployment and an inability to feed their families—particularly within a country’s informal economy—protestors might defy their government “orders” and take to the streets. Inequality will rise. The lower income groups spend a larger portion of income on food, and rising prices will affect the poorest tiers the hardest, possibly exacerbating tensions. Finally, EM governments generally have not provided the same type of income support to their citizens that developed countries have. Further economic deterioration, could cause the protests to boil over, despite governments’ curfew efforts.

ESG factors and risk

We can use our ESG factors to identify potential areas of risk; our source of ESG risk data is Verisk Maplecroft. First, since the driving force in the current world is the coronavirus, a good place to start is with a country’s healthcare system, and then identify those countries at risk from a public health threat. Maplecroft has created a healthcare capacity index that assesses the ability of a country to react to a health crisis. That information is found in Chart 2 below, where we show healthcare capacity graphed against COVID-19 tests administered.

Chart 2: Covid-19 Tests and Healthcare Capacity

Number of Tests per 1 M Population. As of 6/8/2020

Source: Verisk Maplecroft, Wordometers, Brandywine Global. ^[1]

A low healthcare capacity risk score suggests a country is ill equipped to handle a pandemic. Latin America appears overly represented in the high-risk quadrant of the chart and includes Colombia and Peru. In Asia, Indonesia—according to this index—is also an extreme risk country. Brazil is a high-risk country, but the government’s coronavirus response has jeopardized the country’s public health. Brazil has just surpassed the U.K. for the most cases. Population density in Brazil’s favelas has enabled the spread of the virus. The rampant outbreak could raise the specter of growing social upheaval and civil unrest and pose a challenge for the government—particularly one that is generally conservative and dedicated its agenda to fiscal reform.

How does an investor make use of such information? A good question to ask is whether there a correlation between the healthcare capacity index and a country’s credit default swap (CDS), which is the relationship shown in Chart 3. A low healthcare capacity score of 0-2 suggests a higher CDS, while countries with higher capacities are rewarded with lower CDS. We don’t believe the correlation is spurious, as a country with an inability to handle a pandemic crisis should pay more for its debt. That higher cost of debt diverts fiscal support for other areas of an economy, which could feed back into social tensions.

Chart 3: Healthcare Capacity and CDS

Log, As of 4/8/2020

Source: Verisk Maplecroft, Bloomberg, Brandywine Global. [1]

Deep Coronavirus recession and political instability

The global economy is expected to decline—and sharply. That economic deterioration will worsen unemployment rates and negatively affect incomes, which disproportionately falls on citizens that are the least able to manage it: the poor and the low-income worker. Food could become scarcer and more expensive. The coronavirus will only worsen the existing income inequality in the world, but especially in EMs. Widening inequality raises the risks of civil unrest, populist uprisings, and political instability, particularly in those countries facing scarce food supplies. Regime change is certainly a possible outcome from this environment.

Chart 4: Food Security & Civil Unrest

Score (0-10), Q2 2020

Source: Verisk Maplecroft, Brandywine Global. ^[1]

Chart 4 examines the relationship between food security and civil unrest. There is a probability that food scarcity could catalyse civil unrest. The civil unrest variable in our research measures the perceived business impact from protests over a public concern, whether it be economic, political, or social. Food security measures the risk of having an adequate supply. The relationship between food security and civil unrest is a positive one, meaning the risk of not having an adequate food supply could foment an uprising. Chart 4 above plots a country’s food security score from 0-4 on the x-axis. The cluster of countries—India, Indonesia, and the Philippines—would seem to be at a higher risk for civil unrest, as are many countries in Africa.

What could reduce the risk of civil unrest? An effective government could reduce the tendency for social, economic, and political upheaval. Based upon our research efforts, an effective government would be perceived as seeking policies that benefit its citizens. The relationship in Chart 5 suggests ineffective governments are at increased risk for civil unrest. In the COVID-19 era, citizens would trust the government to act in their best interests. Governments deemed as ineffective in the era of coronavirus would be unable to meet the demands and needs of its citizens, who would then resort to an uprising.

Chart 5: Government Effectiveness & Civil Unrest

Score (0-10), Q2 2020

Source: Verisk Maplecroft, Brandywine Global. ^[1]

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[1] Please see Definitions section for definitions of these abbreviations.  Past performance is no guarantee of future results. This information is provided for illustrative purposes only and does not reflect the performance of an actual investment.

Definitions:
– COVID-19 is the World Health Organization’s official designation of the current novel coronavirus disease. The virus causing the novel coronavirus disease is known as SARS­CoV-2
– Environmental, Social, and Governance (ESG) refers to the three central factors in measuring the sustainability and societal impact of an investment in a company or business.
– Emerging markets (EM) are nations with social or business activity in the process of rapid growth and industrialization. These nations are sometimes also referred to as developing or less developed countries.
– Verisk Maplecroft delivers ESG, climate, political, and economic risk data for leading corporations and institutional investors across 150+ countries.
– Worldometer, formerly Worldometers (plural), is a reference website that provides counters and real-time statistics for diverse topics. It is owned and operated by data company Dadax, which generates revenue through online advertising.- — –    – Favela, also spelled favella, in Brazil, is a slum or shantytown located within or on the outskirts of the country’s large cities, especially Rio de Janeiro and São Paulo. A favela typically comes into being when squatters occupy vacant land at the edge of a city and construct shanties of salvaged or stolen materials.
– A credit default swap (CDS) is designed to transfer the credit exposure of fixed income products between parties.

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