“Inflation is relatively stable despite rising short-term expectations, and the US dollar is expected to remain broadly flat. The outlook for US equities is constructive (with an S&P 500 target of 7,000–7,400), with opportunities in small caps and emerging markets, although volatility and performance dispersion are likely to persist, favouring active management,” he notes.

“In fixed income, the focus is on yield through short-duration bonds and credit, with municipal bonds appearing attractive, while investor sentiment is becoming more cautious but not yet at extreme levels.”

He details the outlook across macro, equities, fixed income and sentiment below:

Our forecast for 2026 real gross domestic product (GDP) growth is 2.5% (based on our Global Investment Management Survey^[1]), which is above the Federal Reserve (Fed) forecast of 2.3% and the Wall Street consensus of around 2%. The main drivers of our GDP forecast are the continued capital expenditure (capex) spending by big technology firms, a resilient consumer (Delta Air Lines CEO Ed Bastian discussed both higher demand and revenue in the quarter¹) and expected higher tax refunds in 2026 relative to past years, not to mention the possibility of future interest-rate cuts.

The duration of the current Middle East conflict is the primary risk to our forecast. Higher oil prices resulting from the conflict work like a tax on the consumer, and the negative impacts of higher oil prices will broaden over time.

We expect the Fed to cut rates twice in 2026 and core personal consumption expenditures (PCE) to remain stable in the 2.5% to 3.0% range. The last tick for core PCE data came in at 3.1% for January. The U-3 unemployment rate was 4.4% for February, just off the recent high print in November of 4.5%, which was the highest level since October of 2021. Additionally, last week the Producer Price Index (PPI) data was hot and probably reflects some tariff pass-through.

The conflict in the Middle East, should it persist and drive oil prices higher for longer, could put the Fed in a box with respect to its dual mandate.

Inflation expectations have moved up in the near term. One-year inflation breakeven rates are now 5.10%, an alarming move to say the least, although it is worth adding that there is a first-quarter seasonal component that has historically affected the data. No doubt, higher oil and natural gas prices are driving some or even all of this move. Two-year breakeven rates are 3.32%. Five-year breakeven rates are 2.68%. These numbers represent the bond market pricing annualized inflation expected over the coming one, two and five years. The shorter-term numbers indicate concerns, certainly, but the longer-term, five-year number is still anchored.

On the currency front, we think the US dollar will be essentially flat for the year despite the recent volatility. The US Dollar Index (DXY) last week traded at US$99.17, which is at the high side of its 11-month range, defined as $96 to $100. Many investors are concerned about the US dollar losing value, and some believe the dollar has recently weakened materially, but the fact is that the US dollar is at the same level today as it was in April of 2025 and higher than it was in early July of 2025, late September of 2025 and mid-January of 2026.

Equities

We are constructive on US equities and have established a target range of 7,000 to 7,400 for the S&P 500, based on expected earnings-per-share growth of 8% to 13% year-over-year (based on our Global Investment Management Survey^[1]). We don’t expect this current geopolitical conflict to impact our outlook unless oil trades north of $100 and stays there for months. We expect high levels of volatility to persist in the near term.

Right now, this tape feels like death by a thousand paper cuts. We are held hostage to the situation in the Middle East and expect to be in this pattern until an off ramp comes into view. Let’s look at year-to-date (YTD) performance. Some of this might come as a surprise. Through the close of March 19, 2026 the S&P Midcap Growth Index was up 5.05%, the Russell 2000 Value was up 3.43%, the S&P Midcap 400 Index was up 2.29%, the Russell 1000 Value Index was up 2.13%, the S&P Equal Weight 500 was up 0.97% (the Equal Weight Index is a measure for the average stock, which means the average stock is up), and the Russell 2000 Index was up 0.79%. That’s the good news. On the downside, the Magnificent Seven basket (the stocks of Alphabet, Amazon, Apple, Meta, Microsoft, Nvidia and Tesla) was down 9.46%, the Russell 1000 Growth Index was down 7.87%, the S&P 500 Index was down 3.23%, and the Russell 1000 Index was down 3.16%. The downside appears manageable for diversified portfolios but is probably painful for anyone not diversified. The dispersion in returns sets up an attractive environment for active stock pickers, in my view.

Performance outside of the United States for YTD to last week, the MSCI Latin America Index was up 7.37%, the MSCI Emerging Markets Index was up 2.02%, and Japan (Nikkei 225 Index) was up 2.06%. The MSCI Europe Index was down 3.80% and India (Nifty 50 Index) was the laggard, down 14.72%. All of the international return data is in US-dollar terms.

Our outlook for forward earnings growth makes us bullish for US small-cap stocks and emerging market (EM) equities.

Let’s talk about where we are right now and how to deal with this conflict and the volatility it is creating. It’s time for discipline over emotion; it’s time to have a plan. If you have cash to put to work, keep watch on the S&P Volatility Index (VIX). If the VIX closes above 30 on a weekly basis, I think it’s probably an attractive time to dollar-cost average into equities. This is step one.

Since 1990, when the VIX closed at 30 or higher on a weekly basis, forward returns for the S&P 500 were positive. Ranking three-month forward returns for those periods, the median was 6.85%, and the hit rate was 80.28% for positive returns. The six-month median forward return was 15.15%, and the hit rate was 80.28%. The one-year median forward return was 23.46%, and the hit rate was 88.57%. Again, favor discipline over emotion.

Similarly, if market movements get out of hand, and the VIX index closes over 50 on a weekly basis, in my playbook it becomes time to be even more active. This is step two. Rather than dollar-cost averaging, my approach is to buy quality stocks on price weakness, even baskets like the Magnificent Seven. In the periods since 1990 when the weekly VIX closed above 50, the median forward return one-year was 24.06%, with a 100% hit rate. Again, I emphasise discipline over emotion.

Consider the “Rule of 16” as a forecasting tool to help gauge the magnitude of potential price movements when the VIX is elevated. The calculation is (VIX level/16) = likely price movement in percentage terms. A VIX reading of 32 (32/16) = 2% movement.

At the bottom line, our Institute believes it’s best to have a diversified equity playbook including large, mid, and small-cap exposure in the United States with a balance of growth and value. The same can be said for ex-US equity exposure. We favor positions in EMs and developed international markets. To act on the broadening theme, consider reducing concentration and diversifying portfolio exposure. The VIX index parameters described above can be helpful for deciding further action.

Fixed income

We expect US 10-year Treasury bond yields to trade in a range of 4.0% to 4.25% during 2026. Last week, the yield rose above the high side of that range, to 4.29%. The two-year Treasury yield discussed in the Macro section also punched above its range, trading at 3.85% at the end of last week. The US yield curve has flattened recently, with the two-year-to-10-year spread falling to 45 bps. We expect bull-steepening of the yield curve in 2026.

We expect short-duration fixed income mandates and corporate credit to outperform cash during 2026. Considering our views on US 10-year Treasury yields, we do not expect duration to be a significant driver of total return this year. Rather, all-in yield capture seems to be the play.

Credit spreads have made big moves in the last week. Investment-grade (IG) spreads (one-year/three-year option-adjusted spreads, or OAS) are 64 bps over Treasuries. High-yield (HY) spreads, as proxied by the Bloomberg US Corporate HY OAS, reached 306 bps over Treasuries in the past week. Corporate fundamentals appear healthy to us, although there is stress in the system now.

Historically, when IG spreads trade at 200 bps over Treasuries, forward returns for the Bloomberg US Aggregate Index have been positive over the coming three, six, nine, and 12 months. The spreads have not risen to that threshold, obviously, but if they reach that level, this historical data suggests it may be an attractive time to invest. Similarly, when HY spreads trade at 600 bps over Treasuries, forward returns have been positive three, six, nine and 12 months out. Again, markets are not at that point, but analysing this data offers some historical context.

We are bullish on municipal bonds again this year and find taxable-equivalent yields to be attractive, along with robust fundamentals. Importantly, the increased supply that hit the marketplace in 2025 has run its course for now, and muni bonds have been performing well since last August. We think this positive trend can continue.

Sentiment

The percentage of bullish investors in the latest AAII Investor Sentiment survey dropped to 30%, down two ticks from the prior week’s reading. The percentage of bearish investors rose again and is now at 52.0%, up six ticks from the prior week.

Neither of these readings is at an extreme, but sentiment is growing more cautious by the week.

————–

Notes:
[1]: Global Investment Management Survey

Source of data (except where noted) is Bloomberg as of March 20, 2026. There is no assurance that any forecast, projection or estimate will be realized. An investor cannot invest directly in an index, and unmanaged index returns do not reflect any fees, expenses or sales charges. Past performance is not an indicator or a guarantee of future performance. Important data provider notices and terms available at www.franklintempletondatasources.com. The Franklin Templeton Institute Global Investment Management Survey is a biannual outlook survey designed to give a view across our investment teams. The Franklin Templeton Institute identifies the median across the survey answers and develops the outlook. The survey received responses from around 200 portfolio managers, directors of research and chief investment officers, representing participation across equity, private equity, fixed income, private debt, real estate, digital assets, hedge funds and secondary private markets. Each of our investment teams is independent and has its own views.

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In a new paper, Chris Galipeau, Senior Market Strategist and Lukasz Kalwak, Market Strategist at the Franklin Templeton Institute have examined how financial markets and the broader macroeconomic backdrop evolve when the Fed resumes cutting rates after a pause.

They noted, “Historically equities appear likely to grind higher amid rising volatility. Not all cuts are the same. Early cuts in a cycle historically have been bullish and come with relatively low volatility. Interest-rate cuts after a pause, by contrast, have been typically associated with higher short-term volatility, but they have nonetheless averaged strong one-year returns across equity styles. On average, the Russell 2000 Index small caps gained about 20% and the Nasdaq Composite technology stocks gained about 25% one year after such cuts

“Fixed income also benefits. Fixed income has historically participated in these rallies as well, with US Treasuries returning around 6% and corporate bonds around 8% in the year following a pause-cut

“GDP growth has typically continued, and although corporate earnings have made only minor progress, price multiples have expanded significantly. Post-pause cuts have often coincided with P/E multiples expanding by over 20% within the first year, underscoring the powerful role of monetary easing in driving equity prices higher despite economic challenges.”

“Probably the most surprising finding of our study is that interest-rate cuts following a pause have not historically provided a strong boost to corporate earnings. In the current environment, one could argue that the Fed is already late in making its next cut, with a softer labor market and the drag from tariffs already likely to weigh on corporate earnings. That said, it is worth remembering that US corporate earnings have risen for seven consecutive quarters at a pace of at least 8.5%,4 suggesting that the resilience of US firms may be underappreciated in this framework.

“Still, the historical record speaks for itself: Much like equities, earnings outcomes have been highly variable, ranging from robust +37% earnings-per-share (EPS) growth in 2003 to a sharp -24% contraction in 2008.”

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Stephen Dover

As the Trump administration gets ready to focus on its dual agenda of pushing through new tax cut legislation while tackling the growing federal deficit, investors are gearing up to ongoing market volatility and sector-specific impacts from the proposed fiscal policies.

According to Stephen Dover, Chief Market Strategist and Head of Franklin Templeton Institute, “Congress must act which requires building legislative coalitions. While this may appear less exciting than topics such as DOGE and tariffs, it could be of greater significance for investors.”

Republicans recognise the political imperative to pass legislation extending provisions of the 2017 tax cuts that otherwise expire and would therefore impose a significant and unpopular tax hike on many Americans next year. They are also aware that they must pass legislation to fund the government’s operations.

“The requirements of ordinary governance are now likely to supersede the politics of executive orders, suggesting a very different environment for investors over the coming months,” Dover adds.

“The passage of legislation to extend or expand tax cuts and fund legislation will likely be a heavy lift for Congress. And it could take months of difficult negotiations among Republicans in the House of Representatives and the US Senate.

“That means that if market conditions worsen due to economic weakness, in our view, timely legislative intervention is unlikely. Investors expecting solid market returns for the remainder of 2025 based on new tax and spending legislation from Congress may have to be patient to see those anticipated outcomes.”

Part of the legislative challenge is the narrow Republican majorities in Congress, above all in the House of Representatives. While many Republicans favour tax cuts, some demand significant spending cuts to accompany them. These cuts can only be achieved through reforms to entitlement programs like Medicaid, which serves many Republican voters in rural communities.

What does this mean for investors? “Two things strike us as likely,” Dover says. “Firstly, existing tax provisions of the 2017 code will be extended. Secondly, the political will to pass large tax cuts, which must be financed by painful budget cuts, is probably impossible to achieve this year.”

“In our view, tax cuts are unlikely to help the economy or markets, and the Federal Reserve is likely to remain on hold until it feels comfortable that inflation will recede once tariff impacts filter through the data. If US growth and earnings expectations stumble, neither fiscal nor monetary policy appears in a position to offer quick relief.

“Investors are probably relieved that uncertainties of Trump’s first 100 days of DOGE cuts and tariff are receding. But in many respects, the hard work is just beginning, requiring significant effort and political skill to deliver the outcomes investors hope to see.”

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Stephen Dover

Following a sharp retreat in both U.S. and global equity markets, another pillar of the financial system has come under pressure: the U.S. bond market. In a matter of days, the yield on the benchmark 10-year U.S. Treasury has surged by nearly 50 basis points, raising alarm bells across Wall Street.

However, Stephen Dover, Chief Market Strategist and Head of Franklin Templeton Institute, believes the market turmoil may not be rooted in fundamentals, but rather in technical dislocations.

“This spike in yields appears to be more technical than fundamental,” Dover said. “We begin with the facts. Long-term Treasury yields are rising sharply and much faster than short-term yields, leading to a steepening of the yield curve. Why is that happening? In theory, various factors could be behind the jump in bond yields. It might be that investors are worried about inflation, insofar as tariffs will boost US inflation. It could be that investors are worried about large US budget deficits and debt levels. Or it could be that investors are concerned that countries hit by tariffs, such as China or Japan, might stop buying Treasuries or even might sell their massive stockpiles of them.”

The move has steepened the U.S. yield curve significantly, as long-term yields have risen much faster than short-term rates. That kind of curve steepening typically suggests rising growth or inflation expectations. But Dover says neither is supported by the data.

“None of those reasons is, for now, compelling. Measures of expected inflation (based on Treasury Inflation Protected Securities or TIPS) do not evidence a sharp increase in investor expectations. As of April 8, the 10-year breakeven inflation rate from TIPS pricing is a subdued 2.22%. Deficits and debt expectations have not materially worsened. If anything, the tax revenues from tariffs represent fiscal tightening and the odds of the Tax Cuts and Jobs Act of 2017 being extended, and even a large tax cut this year, have not materially changed.

“Finally, if foreign central banks and reserve managers were slowing their purchases of Treasuries, the US dollar would be selling off in tandem with the bond market. While the dollar has softened a bit, it does not appear to be under similar selling pressures.

“The probabilities therefore suggest that leveraged positions in Treasuries (including basis trades or positions in swap markets) are the source of this week’s selling pressures. Of itself, that could be benign—or possibly not. If the selling pressure is contained, we believe little damage will be done. If, on the other hand, one or more financial institutions has gotten “over its skis” and is selling under duress, the Fed might deem it necessary to prevent further financial dislocations.

“However, the Fed’s engagement would probably not be via interest rate cuts, but rather via commitments to provide targeted liquidity.

“Finally, rising long-term interest rates, if sustained, represent a further tightening of financial conditions beyond declines in global equity markets or widening of credit spreads. In that regard, we think they represent a further risk to the outlook for US and global growth and corporate profits.”

In the short term, markets may remain choppy as technical factors work their way through the system. But for now, Dover is urging investors to focus on signals, not noise.

“We’re closely monitoring the situation,” he concluded. “But at this point, the evidence points to technical pressure and not a broader shift in economic outlook.”

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Stephen Dover

Markets have been volatile lately, marked by sharp declines in global equity indexes, bond yields and commodity prices.

Stephen Dover, Chief Market Strategist, Head of Franklin Templeton Institute says “The Franklin Templeton Institute is following market conditions and the fundamentals closely. Across all global regions and major asset classes, our teams of strategists and analysts have gathered to assess what all this means for investors.

“Global equities: All year, we have cautioned that US equity market valuations were excessive and left little margin for disappointment. Our standing year-end S&P 500 Index target has been 5250, only slightly above where the index opened this morning (August 5). We remain cautious. Based on historical analysis of periods of economic deceleration, we believe that growth styles will outperform value, and that quality is also warranted. We are concerned about earnings disappointments—above all for smaller-capitalisation stocks.

“That said, we also respect that positioning, momentum and quant-style trading can be decisive when market ructions occur. While implied equity volatility has spiked (the VIX shot up to 65 this morning—the highest in four years^[1]), the market moves may not have yet run their course. Opportunity will eventually present itself, but we think it is too early for all but the most long-term investors to seek value.

“Non-US markets have been particularly hard-hit, with Japan’s Nikkei shedding over 12% in its second-worst trading day in history. That is a reminder that it is next-to-impossible to diversify equity risk by region (or by sector or style) during major corrections or bear markets. Opportunity will arise, but in our view, it is premature to step in at this point.

“Global fixed income: In recent months we have been strong proponents of extending duration, particularly in US Treasuries. However, as 10-year Treasury yields have plunged to near 3.7% (from near 4.5% earlier this year), it makes sense to us to take some profit. Corporate spreads have not (yet) widened by as much as declines in equity prices might suggest is warranted, but selective engagement into higher-grade and even higher-yield issuers should eventually make sense.

“The outlook for non-US fixed income markets depends (for US investors) to a considerable extent on the outlook for the US dollar. The dollar has slumped against other major currencies in recent days, above all against the Japanese yen as carry trades^[2] have been unwound. To a considerable extent that reflects expectations of significant Federal Reserve (Fed) easing before year-end (futures markets are now pricing in circa 100 basis points^[3]), with an added “push” from risk aversion. We anticipate the dollar will eventually stabilize and even recover, but that could take time. Therefore, for risk-averse, income-oriented investors, we believe non-US fixed income investments offer poor risk/reward trade-offs.

“Alternatives: For some time, we have been cautious about private equity, with a preference within that class for secondaries. The lack of visibility, particularly during periods of rising fundamental risk, makes us reiterate our caution.

“Private credit is slated to be more interesting, particularly if banks become even more reticent to lend. Pricing should improve. Over time, long-term investors should be rewarded by attractive discounts—especially true for investors putting new money to work in this environment.

“Above all, we emphasise the importance of manager selection. “Alpha dispersion” (the gap between top managers and the rest) is likely to increase significantly as a result of market dislocations.

“Finally, this is how we see the fundamentals. US recession risk is clearly on the rise, as reflected by the sharp swing in market pricing. Rising jobless claims, a poor July employment report and signs manufacturing may be contracting have changed the narrative.

“That said, other indicators are less worrisome, including the latest non-manufacturing Institute for Supply Management survey, the second-quarter US gross domestic product report, and anecdotal evidence from retailers.

“It is too soon, in our view, to conclude that the United States is headed toward recession. However, even a more pronounced slowdown can lead to profits disappointments, for which an overvalued equity market was not prepared.

“The Fed will surely cut interest rates in September and thereafter. A 50 basis-point cut is now the market expectation for the September meeting, and an inter-meeting (“emergency”) cut cannot be ruled out. Investors will closely follow the Fed’s sessions in August in Jackson Hole, Wyoming, for clues about its policy.

“Historically, equity markets have had positive returns in the year after the Fed starts cutting interest rates. This is true whether the economy has dipped into a recession or avoided one. The average return one year after the first rate cut in recessionary periods is 4.98%, versus 16.66% in non-recessionary periods. Drawdowns were magnified in recessionary periods after the first rate cut, with the average max drawdown being 20%, versus 5% in non-recessionary periods.

“Globally, there are no “white knights” in the event a recession unfolds. China has shown little inclination to repeat the kind of stimulus it offered 15 years ago during the global financial crisis. Europe and Japan are similarly unwilling or unable to offer “locomotive support” to the world economy. A US election rules out quick fiscal action.

“Markets, therefore, may be slower to react to good news via Fed rate cuts, when they happen, in light of those global constraints.”

———-

Footnotes:
[1] The CBOE Market Volatility Index (VIX) measures market expectations of near-term volatility conveyed by S&P 500 stock index option prices. Often called the “fear gauge,” lower readings suggest a perceived low-risk environment, while higher readings suggest a period of higher volatility. Indexes are unmanaged and one cannot directly invest in them. They do not include fees, expenses or sales charges.
[2] “Carry trade” here refers to borrowing Japanese yen to invest in higher-yielding currencies.
[3] Source: CME (Chicago Mercantile Exchange). As of August 5, 2024. There is no assurance that any estimate, forecast or projection will be realised.
[4] Source: NBER, Federal Reserve Bank of St. Louis, and DJII. Analysis by Franklin Templeton Institute. January 1, 1972 to July 31, 2024.Indexes are unmanaged and one cannot directly invest in them. Past performance is not an indicator or a guarantee of future results.
[5] Ibid.

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