Stephen Dover

The initial public offering (IPO) window is reopening in the US, but the more important story is the scale of the private companies preparing to enter public markets. SpaceX could become the first major test, with OpenAI, Anthropic, Databricks, Stripe, and Anduril potentially creating a wave of new market capitalisation large enough to reprice growth equities more broadly, according to Franklin Tempelton.

“SpaceX is the bellwether. A SpaceX IPO would force investors to value a unique mix of orbital launch, Starlink broadband, defense-adjacent infrastructure, and long-duration opportunity. Demand for this IPO is unlikely to be the issue; the real test will be valuation, governance and how much capital intensity public investors are willing to absorb,” says Stephen Dover, Chief Market Strategist and Head of Franklin Templeton Institute at Franklin Templeton.

“Artificial intelligence (AI) platforms are harder to underwrite. OpenAI and Anthropic would bring extraordinary growth and strategic importance to the market, but also meaningful uncertainty around compute costs, margin structure, capital needs and the timing of free cash flow.

“Supply remains the underappreciated risk. If several mega-cap IPOs come in the same window of time, they will compete for capital not only with each other, but also with existing publicly traded growth stocks. That could create rotation pressure across software, semiconductors, fintech, defense tech and AI beneficiaries,” notes Dover.

“From an investment perspective, we think this should be treated as a selective stock-picking opportunity, not a broad IPO trade. The best opportunities will likely be companies with category leadership, strong unit economics, and a clear path to profitability, while weaker deals could struggle quickly in the aftermarket.

“Private valuations will be tested again. Public markets will likely provide a real-time reset for late-stage private companies, especially those that raised capital at aggressive valuations during the prior cycle.”

Is this the return of the IPO? According to Dover, “A healthy IPO market should improve exit activity, recycle capital back into venture and growth investing and support broader risk appetite, while a weak aftermarket could close the window quickly. IPOs provide an exit opportunity for private investors.”

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Sonal Desai

Franklin Templeton Fixed Income economists weigh in on the future of monetary policy across the globe

The findings are listed below covering the US, Europe, Japan economic outlook and outlook for currencies.

US economic review

US economy: Growth over inflation, for now

Policy easing to resume: Financial conditions have eased to mid-2020 levels. Inflation data, while stable, shows signs of persistence in non-housing services and input prices, indicating that the case for easing rests squarely on the perceived risks to employment.

Labor market slack is building, but it’s not all gloomy: Despite the slowdown in labor demand, wage growth has remained above 4% for the past year. Interestingly, wage growth has eased for lower-income groups, implying that tighter immigration has yet to translate into higher wages for low-skilled workers.

Cautiously optimistic on economic activity: July spending data confirmed that the “payback” from tariff front-running abated as spending rebounded, especially in durable goods, supported by real income gains. This is significant because, like goods-sector employment, durable goods are typically the first category to show signs of cooling. However, tariff-inflation and reduced transfer payments may soon pressure lower- and middle-income households. Corporate profits remain resilient, but margin pressures are rising due to significant tariff-related costs. Many firms are reportedly renegotiating supplier terms, restructuring supply chains, and/or passing increased costs on to customers. Meanwhile, corporate concerns over wage pressure have eased and the probability of layoffs remains limited. Regional Fed surveys show a gradual recovery in firm capital expenditure (capex) intentions, corroborated by rising new orders and imports for capital goods. A sharp upward revision to intellectual property investment in the second estimate of the second quarter GDP likely reflects a lift from enterprise spending on generative AI products, suggesting that firms are actively investing in productivity enhancing measures.

Inflation in transition; risks to the upside: Shelter inflation is easing and will likely continue to do so in our view, but non-housing core services inflation has begun to reaccelerate. The latter is a key area of concern since elevated wage inflation could continue to drive up prices in the most wage-sensitive parts of non-housing core services. Immigration constraints may exacerbate this issue. With goods inflation, the bulk of the tariff impact is likely still ahead of us. A large share of US imports remains duty-free and with importers reducing purchases from high-tariff countries; actual tariffs paid were just over 9% as of June compared to a theoretical rate of 16% based on 2024 import levels. We expect this gap to narrow in the months ahead. Producer prices may well be starting to reflect tariff impacts, and if they continue outpacing consumer prices, corporate profits may weaken, prompting firms to scale back hiring or even consider layoffs.

Fed policy: Market are anticipating a 25-basis-point interest rate cut in September, followed by another in December. However, rising tariff-driven inflation may limit further easing. In our view, the scope for meaningful declines in short-dated Treasury yields appears limited since Fed policy expected to normalise rather than turn overtly accommodative over the next year. Moreover, the bar for the Fed to signal a more aggressive easing stance remains high. At the long end of the yield curve, although term premium narratives have taken a backseat to near-term Fed policy expectations, the overall level of term premium remains elevated. Looking ahead, we expect term premium to rise, with the possibility for some bear steepening.

European economic outlook

EU economy: Cautious optimism due to fiscal hopes

Lackluster growth in the short-term, but economic revival through fiscal stimulus: Cautious optimism characterises our medium-term outlook for the euro-area (EA), due to the expected impact of Germany’s fiscal stimulus, which the market appears to be under-appreciating. Germany’s draft budget in June announced sizeable fiscal spending (amounting to approximately 20% of 2024 GDP) over the next four years, with significant front-loading expected. However, headwinds persist in the near term. The overall growth trend across the euro-area remains sluggish, with inventory building largely driving second-quarter growth [0.1% quarter/quarter (q/q) and 1.4% year/year (y/y), with growth]. Although exports were a negative contributor (-0.5% q/q), the payback from the front-loading of trade in the first quarter was lower than expected. More striking was the slowing in private consumption and in investments in the largest four EA economies (Germany, France, Italy and Spain), attributed to uncertainty and low confidence amid trade-related uncertainty.

Modest business optimism versus timid consumers: Nonetheless, leading indicators, such as business surveys, have shown improvement. The composite Purchasing Managers’ Index of manufacturing rose to a 3.5-year high in August. This trend is also being reflected in a clear improvement of the expectations component of the German Ifo index, driven by an expected positive impact from fiscal stimulus. In contrast, consumer confidence surveys remain weak, despite a modest pickup during the first quarter that has since flatlined. Consumers remain reluctant to spend, with savings still above pre-COVID-19 levels. As confidence returns, a high savings rate coupled with real income growth should support consumption over the medium term.

ECB—not overengineering monetary policy: As expected, the ECB left the policy rate on hold at its September meeting (at 2.00%) in a unanimous decision. The overall tone of the press conference was broadly unchanged from July, reiterating that the ECB is “still in a good place” but “not on a predetermined rate path.” A few hawkish tones were struck on the outlook and inflation. Growth risks are now seen as more balanced compared to July, mostly due to the US-European Union (EU) trade deal, which supposedly eliminates the risk of higher tariffs and EU retaliation risks (which we were always skeptical about). Regarding the near-term outlook, policymakers held a sanguine view of the growth trend in the first half of 2025. On inflation, the ECB noted that “the disinflationary process is over” meaning that most of the moderating forces from previous years will normalise. However, wage growth is expected to decline further, with labor markets expected to remain stable—a fundamental assumption of ECB policymaking.

The ECB updated its June growth and inflation forecasts. Growth in 2025 was revised higher to 1.2% from 0.9%, while the 2026 forecast was lowered to 1% from1.1%. Contrary to our expectations, the German frontloaded fiscal stimulus growth impact was not revised higher following the draft budget of late June. In our view, the potential impact has been underestimated. Meanwhile, inflation forecasts were revised down slightly, including confirmation of the undershoot in 2026.  In post-meeting comments, President Lagarde expressed that the ECB would not react to minimal inflation deviations from the target, assuming they remain small and temporary.

Overall, we do not envisage further rate cuts unless growth or inflation materially disappoint over the next six months, with the window for easing progressively narrowing as the German fiscal impulse should become more visible in 2026.

Rates—front end can steepen further, long end support will remain limited: The front-end of the yield curve has been well anchored since post-Liberation Day, with investors pricing out some easing after the ECB’s July meeting. There is scope for the curve to steepen in the 1–3-year sector as the German fiscal impulse becomes more tangible. Longer-dated maturities are likely to remain under pressure amid a broader global move and local drivers. As well as higher supply from Germany, anticipated Dutch pension reforms that are due to come into effect in January are expected to weigh on demand.

Japan economic outlook

Japan’s economy: October hike on the table

Growth—the resilient economy underscored by second quarter GDP numbers: The Japanese economy showed resilience in the second quarter 2025, with GDP growth rising by 0.5% q/q and 1.7% y/y. Private consumption and overall investment were solid, offsetting a flat public spending. Exports were strong, adding to growth, while imports were slower, resulting in a positive contribution to growth from net trade. Despite concerns over tariffs, Japanese firms, especially in the auto sector, managed to maintain export volumes by squeezing export prices. However, the third quarter is expected to see a slight decline in GDP due to adjustments in export prices and the impact of amendments to the Building Standards Act on private housing investment.

High-frequency indicators suggest a modest deceleration in growth for the second half of 2025, with large manufacturers’ sentiment improving and consumer confidence rising but the outlook worsening. Yet, services, which account for nearly 70% of GDP, continue to drive the economy forward, supported by a rebound in tourist flows. Despite a slower third quarter, we expect full-year growth should remain solid at 1.1% y/y.  Prime Minister Ishiba’s resignation paves the way for some political uncertainty over who the leader will be and how the fiscal package shapes up. These will be crucial not only for the economy but also for asset prices.

Inflation—the curious case of rice inflation: The headline consumer price index (CPI) remained strong at 3.1% y/y and core CPI (excluding fresh food) also at 3.1% y/y. Government subsidies have been distorting actual inflation, but underlying inflationary momentum remains strong. Food prices, particularly rice, continue to drive overall inflation, with manufacturers passing on higher costs to output prices. The Tokyo Ku area CPI showed a slight decline in August, but overall inflationary pressures persist. Weekly retail rice prices are again ticking up (chart below) after a dip in June-July indicating that prices are stickier and taking longer to revert to normal despite the government’s measures of releasing stockpiles. Sustained food inflation (especially of staples) can lead to inflationary expectations becoming more entrenched in households, a risk the BoJ has flagged earlier.

BoJ—gradual tightening to continue: The BoJ is expected to continue its gradual tightening trajectory, with a 25-basis-point rate hike anticipated in October and at least three more in 2026. Wage growth progression and the stickiness of food inflation are key factors likely to influence the BoJ’s future rate decisions. Despite long-end yields reaching record levels, we think the outlook for Japanese Government Bond (JGB) yields remains bearish due to fiscal expansion uncertainties until clarity emerges on Prime Minister Ishiba’s successor.

Overall, forecasters generally expect the Japanese economy to maintain resilient growth in 2025 and 2026, with GDP averaging 1.1% y/y in 2025 and slowing slightly to 0.8% y/y in 2026. Inflation is forecasted to remain above 3% for the rest of 2025, driven by high food prices and gradual but persistent services prices.

Currency outlook

US dollar (USD)

After a period of significant depreciation earlier this year, the dollar stabilised and has begun to realign with traditional cyclical drivers. Although the US Dollar Index (DXY) continues to trade at a discount to the weighted two-year rate differentials, the gap has narrowed. Our analyses confirm that short-end US yields have become more influential than global equities or commodities in shaping USD movements. This marks a departure from the earlier dominance of structural and policy uncertainties. Moreover, the sharp narrowing of the goods deficit, which bodes well for the current account position, and foreign investors’ return to US assets, particularly US equities, since April imply reduced balance-of-payments pressure on the USD to weaken.

However, despite these improvements, it may be premature to conclude that the dollar has bottomed out. The United States continues to run twin deficits—a fiscal deficit of around 6.5% of GDP and a current account deficit near 4%—both significantly worse than in 2018–2019. These imbalances could undermine the dollar’s attractiveness, even with its interest rate advantage. Moreover, the US’ yield advantage is expected to fade over time as the overall direction of monetary policy is geared toward easing. By mid-2026, the Fed is expected to be the only G10 central bank still easing policy, while others begin tightening. Relative growth has historically been of greater significance to foreign exchange markets, and although US economic growth has remained resilient, its relative performance compared to G10 peers is expected to become less exceptional. Additionally, Deutsche Bank’s research suggests that the curvature of the yield curve—not just the level of short-term rates—can significantly influence currency markets. A flattening of the curvature—where medium-term rates fall faster than short-term ones—signals weaker growth prospects and can deter capital inflows, which in turn is bearish for the USD.

Euro (EUR)

Fundamental and technical factors remain supportive of further euro appreciation, in our view, albeit relatively contained compared with its strong performance since March. As well as the cyclical support from an improving macroeconomy, structural trends remain in place that we believe should further underpin the euro: the increasing market size of the European Government Bonds (EGBs), rising credit quality, tighter sovereign spreads, and historically attractive yields.

On the demand side, international investors are driving flows for euro-denominated assets, although this trend is more evident in fixed income rather than equities. ECB data for the second quarter showed that non-EA investors bought a significant amount of EGBs. Despite a rise in interest from EA debt securities from the rest of the world, repatriation from the United States has been marginal. This is mostly attributable to ongoing EA purchases of US stocks, while being a net seller of US Treasuries. While investors positioning remains undoubtedly overweight the EUR, markets seem to underappreciate narrowing growth differentials with the United States in 2026.

Japenese yen (JPY)

Our broad call for a stronger yen in the medium-term remains unchanged. But we remain more on the sidelines in the near term. There are factors on both sides (yen and dollar) that are preventing USD/JPY from breaking lower, but we continue to believe that it is inevitable partly because of the yen’s cheap valuations.

Several factors are liming the yen’s strength in breaking out of current levels: the BoJ’s muted responses or forward guidance on further tightening, domestic political instability and the uncertainty over the new Prime Minister and government’s fiscal policies as well as extended short USD/JPY positioning despite recent correction. Until positioning adjusts materially, it will be hard for the yen to capitalise on dollar weakness (as we have seen in recent months). Technically, a Fed cut coinciding with a BoJ hike would be crucial for USD/JPY to trend materially lower, in addition to positioning adjustments. But for now, we believe domestic political and fiscal risks will limit a clear pivot in that direction.

Franklin Templeton Fixed Income team of economists including Sonal Desai, Chief Investment Office, Nikhil Mohan, Economist, Angelo Formiggini, Economist and Rini Sen, Economist.

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Michael Browne

As AI transforms industries, its massive energy appetite is straining existing infrastructure. Innovative solutions are needed to meet growing demands, driving investments in new energy sources and intelligent grid systems according to Franklin Templeton Institute.

“It is increasingly apparent that the artificial intelligence (AI) boom is anything but artificial. AI is real and it is infusing its applications across industries, enabling advancements in health care, finance, transportation, manufacturing and business services. The proliferation of AI across the world’s economy will, however, require massive investments,” notes Michael Browne, Global Investment Strategist at the Franklin Templeton Institute.

In the United States, the “Big Four” (Microsoft, Amazon, Alphabet and Meta) are forecast to have spent more than US$3 trillion on AI by the end of the decade.^[1] Much will be in developing and securely transmitting the power that hungry banks of AI processors require. AI has a massive appetite for electricity, creating both challenges and opportunities for investors. Accordingly, AI will also foster significant innovation and investment in the efficiency of production, distribution and storage of electricity.

As AI models become larger and more complex, their demand for energy inputs is rapidly growing. Presently, AI usages absorb about 4.5% of total US electricity production, equivalent to or that of roughly 20 million American homes or Spain’s current total electricity consumption. By 2035, AI may account for 5% of all energy usage around the world.

Browne adds, “Those trends will place enormous pressures on existing energy infrastructure and will require significant investments in energy supply and in electricity transmission, security and resilience. Over the next five years, the energy infrastructure needed to support AI growth will occur in three areas: data centre expansion and optimisation, power generation and grid modernisation.”

At the heart of AI’s energy demands are data centres, which are the physical hubs where AI is trained, deployed and run. As models grow more complex, with trillions of parameters and real-time inference requirements, the computing power required is increasing exponentially. Given the strong commercial interest in AI applications across all sectors of the economy, data centre capacity is expected to double by 2030, and AI could account for up to 20% of total data centre power consumption.

It appears increasingly likely that AI’s massive energy needs cannot be met solely by boosting energy production and distribution, as necessary as those developments are. Innovations in efficiency and alternative sources of energy will also be required.

AI hardware such as TPUs (tensor processing units) and GPUs (graphics processing units) require calibrated cooling systems and associated energy management software. Innovations like immersion cooling or waste heat reuse can reduce energy usage per computation and will become more important as energy demand rises. Indeed, without energy optimisation advancements, AI-driven data centre power consumption could reach unsustainable financial and environmental levels within a decade.

To support the expanding energy needs of AI, the global energy generation mix must shift toward scalable and sustainable sources. Currently, many data centres are powered by fossil fuels, which not only contribute to carbon emissions, but are also vulnerable to price volatility and supply disruptions.

Over the next five years, AI-related energy needs will increasingly be met by renewable sources such as solar, wind and hydropower. In some novel cases, small-scale nuclear reactors are being purpose-built to power AI infrastructure. Hyperscale data center operators are already investing in private power purchase agreements (PPAs) with renewable energy providers, aiming to secure long-term, carbon-free electricity. However, renewables pose challenges due to their intermittent nature.

“To mitigate those challenges and to enhance energy security, energy storage technologies, particularly utility-scale batteries, will be essential. These systems can store excess power generated during peak renewable production periods and release it during demand spikes. AI can assist by optimising energy forecasting, grid balancing and demand response through real-time analytics,” Browne noted.

With regards to energy transmission needs, traditional centralised grids are incompatible with the decentralised demands of AI infrastructure. More modernised, i.e., “smart” grids, will become necessary. Their development will involve upgrading transmission lines, deploying real-time monitoring and control systems, and integrating local sources of power, including wind, solar, nuclear and battery supplies.

For example, smart grids allow power to be continuously and instantaneously allocated as needs arise, helping to meet demand surges caused by AI needs. AI centres can also enhance grid resilience through load forecasting and adaptive energy routing.

“For investors, we believe the next five years represent an opportunity to capitalise on this shift. The energy sector in all its dimensions must support a vast increase in computational power while simultaneously transitioning toward sustainable production and distribution. It must also enhance resilience and security. All these needs will require significant investment in new sources of energy, power generation, distribution and intelligent, flexible grid systems.

“In our opinion, it is a once-in-a-generation opportunity.”

——–

Endnotes:
[1] There is no assurance that any estimate, forecast or projection will be realised.

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The capital expenditures (capex) from the Magnificent Seven^[1] are 4x-8x larger than the Marshall Plan, Apple’s Foreign Direct Investment (FDI) into China, US aid to all nations last year, and the gross domestic product (GDP) of around 75% of all countries.^[2]

“It isn’t just “Big Tech;” it’s “Colossal Tech.”  History has shown that spend at this level changes the course of nations. And the amount is growing. As economists weigh the impact of tariffs, interest rates and the national debt, the Colossal Tech spending may not merely be a factor but instead the factor in forecasting the US economy,” says Moberg.

In the attached paper, he looks at the scale of tech investments as the most important factor to consider when assessing US economic growth covering the following themes.

• The difficulty of conceptualising large numbers: In investing circles, it is increasingly popular to discuss how difficult it is for humans to understand exponential growth. Our minds work in a linear way, so it is counterintuitive that doubling a small number again and again leads to a very large number very quickly.
• The Marshall Plan: In 1948, the United States introduced the Marshall Plan, which sought to rebuild the war-torn economies in Europe after World War II. Publicly, the chief administrator billed the plan as “the most generous act of any people, anytime, anywhere, to another people.” Sixteen nations, including the United Kingdom, France, Germany and Norway, all received aid.
• Apple in China: In 2016, Apple Computer agreed to spend US$275 billion over the following five years to enhance its manufacturing in China.³ That was US$55 billion per year, about twice the size of the Marshall Plan in today’s dollars. The goal of this investment, at least as expressed to shareholders, was simple and pure: generate a strong return on investment for the company.
• The AI Multiplier Effect: One of the most common questions we receive these days is: “When will we see the effects of AI?” We would argue that today’s capital expenditure (capex), which is a proxy for overall spending, is happening right now.

“It is our view that AI spend may be the thing to watch to track the health of the US economy.

“The Marshall Plan was implemented when there was no European Union. It succeeded despite the complexity of 16 different currencies, border patrols, controlled immigration and tariffs between countries. Similarly, the story of China during the years of the FDI from Apple was not uncomplicated. There was a fear of a housing bubble, the re-education of highly successful internet CEOs, and a large rise in international concern over technology sharing, including western bans of certain products. And yet China continued to make massive economic and manufacturing gains.

“As these other examples show, the most accessible way out of many economic problems is growth. Yes, the US economy has some issues today, including tariffs, debt levels, housing starts, student loans and many other legitimately concerning trends. But we believe the sheer size and potency of today’s AI spend should not be overlooked.

“We do not consider ourselves experts in economics. However, we have studied technology and tech spending for over 25 years.

“And we can confidently say that we are experiencing one of the biggest investment cycles in human history, one that dwarfs the largest successful spending plans of the past. The United States and the West stand to be massive beneficiaries of this investment.

“Thus, what happens with AI capex may very well be the most important driver of the US economy and markets going forward, and, on that basis, we believe the future looks bright.

“In investing, there are so many different and important data points. The objective of an investor is to have a clean and clear thought and to distil which of many data points matter. In our view, although tariffs, debt levels and inflation are very important to forecasting the US economy right now, the big thing to watch is capex spend,” he adds.

——–

Notes:
[1] The Magnificent Seven comprises Alphabet, Amazon, Apple, Meta, Microsoft, NVIDIA and Tesla.
[2] Source: “GDP by Country.” Worldometers. Accessed July 14, 2025. US government foreign aid in 2024 was around US$52 billion.
[3] Source: McGee, Patrick. Apple in China: The Capture of the World’s Greatest Company (New York: Simon & Schuster, 2024).

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“We are thrilled to have a high calibre professional like Rebecca join our long-standing and trusted organisation. Her appointment rounds out our distribution team to expand and deepen our intermediary relationships in Australia, boosting distribution of our suite of quality investment solutions across all asset classes,” Franklin Templeton’s Managing Director and Head of Australia and New Zealand, Felicity Walsh, said.

Morgan was previously head of intermediary distribution at Coopers Investors. Prior to that she was a key account manager at Ausbil Investment Management and a sales director at PM Capital.

She has also held roles at Pengana Capital, BT Investment Solutions and Perennial Investments in a career spanning over two decades working with financial advisers and consultants across various asset classes.

“Rebecca is a deeply experienced sales professional with strong relationships in the Victorian market and southern region. Her addition to the team reflects the technical nature of investment sales in funds management distribution and matches the diverse needs of our clients across wealth, wholesale and retail,” Walsh said.

“I am excited about joining internationally renowned Franklin Templeton and using my varied experience in the industry to contribute to its growth trajectory. I am passionate about finding high quality investment solutions for our clients across the board,” Morgan added.

Earlier this year Franklin Templeton listed the Franklin Australian Absolute Return Bond Fund (ASX: FRAR) and the Franklin Global Growth Fund (ASX: FRGG) on the ASX as it seeks to expand its funds to a wider audience. Franklin Templeton also expanded its investment capabilities available to Australian investors this year by launching three new managed funds – Brandywine Global Opportunistic Equity Fund, Martin Currie Active Insights Fund and Franklin Government Cash Fund.

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US Federal Reserve

At the recent US Federal Reserve’s (Fed’s) 2024 Jackson Hole Economic Policy Symposium, Fed Chair Jerome Powell stated that the US labor market is no longer overheated. Powell also noted that while inflation has abated, risks to growth and employment have increased.

“For investors, Powell’s language is significant. Not only does it cement the case for the Fed to ease at its September 17-18 meeting, it also signals a readiness for further rate cuts through the end of the year and into 2025. Those moves could have profound implications for investment returns across asset classes,” says Stephen Dover, Chief Market Strategist and Head of the Franklin Templeton Institute.

“The Fed has pivoted from fighting inflation to ensuring the health of the US economy. In what follows, we outline what data will matter most to the Fed and, by extension, for financial markets. Various key indicators will be revealed in the August employment report, slated for release at 8:30 am EST on Friday September 6.

“The top indicators, in our view, include initial jobless claims, non-farm payroll employment, the labor force participation rate, and temporary job losses,” notes Dover.

Labor market normalising

“Importantly, the US labor market is normalising, meaning that labor supply and demand are moving closer into balance. That follows a lengthy adjustment process following adverse labor supply shocks due to the COVID-19 pandemic. One example: The ratio of job openings to unemployed persons has decreased to 1.2 in June, close to its pre-pandemic levels.^[1]

“The biggest factor in restoring balance between labor supply and demand has been the return of workers to the labor force. The labor force participation rate for prime-age workers, aged 25 to 54, increased to 84% in July, touching its highest level in more than two decades.^[2] Increased labor supply relieves upward pressure on wages, which contributes to a moderation of business costs and hence in overall US inflation.”

Concerns over recession risk are overstated

“The rise in the unemployment rate to 4.3% in July triggered the so-called “Sahm Rule,”^[3] which has historically been a reliable indicator of US recessions. That may be one reason why the Fed has shifted its policy emphasis from inflation to growth. However, our analysis indicates that the Sahm Rule is a lagging indicator for the business cycle and is typically triggered once a recession is already underway.

“More importantly, the Sahm Rule has historically been triggered by a larger increase in the number of unemployed persons as compared to the increase in labor force. That is not the case today. Instead, job gains remain positive, with the rise in the unemployment rate accounted for primarily by an increase in the participation rate as workers return to the labor force.

“To be sure, a spike in temporary layoffs has also lifted the unemployment rate. That bears watching, should temporary job cuts become permanent. But we think it is premature to conclude that permanent job losses are likely, much less inevitable.”

Watch payrolls

“Historically, a triggering of the Sahm Rule has coincided with a US recession in every instance except 2003. Hence, the unemployment rate will remain a closely watched indicator. But investors are likely to look beyond the unemployment rate, per se. They will want to see whether any further rise in the unemployment rate is due to actual job losses or to further gains in labor force participation. That means weekly jobless claims (a rising number indicates more workers are being laid off), temporary layoffs becoming permanent, and the overall rate of nonfarm payroll gains (or losses) should be the key data for investors.

“Based on data through July, changes in nonfarm payroll employment are not consistent with a deteriorating economic situation. Typically, when the economy is fully employed and economic growth is near its trend rate, monthly job gains are in the vicinity of 125,000.^[4] The three-month moving average of job gains as of July is 169,667,^[5] still above that pace. It is equally true, however, that the pace of jobs growth has declined since May.

“Markets will therefore watch the August employment report to see if the downward trend in jobs growth is extended. However, over the past month initial jobless claims have dipped, suggesting the pace of layoffs may be slowing. Recall, temporary distortions from Hurricane Beryl caused some of the increase in jobless claims.^[6]

“In conclusion, although the rise in the unemployment rate has triggered the Sahm Rule, things look different this time. Job losses are modest and temporary, not large or permanent. There is not sufficient cause currently for alarm, in our view.

“Nevertheless, investors will likely be laser-focused on the US labor market, above all the key indicators of jobless claims, non-farm payrolls, temporary job losses and the participation rate for any signs of genuine growth and earnings risk.”

——–

Notes:
[1] Bureau of Labor Statistics, Macrobond. Analysis by Franklin Templeton Institute.
[2] Bureau of Labor Statistics, Macrobond.
[3] The Sahm Rule identifies signals related to the start of a recession when the three-month moving average of the national unemployment rate (U3) rises by 0.50 percentage points or more relative to its low during the previous 12 months.
[4] Bureau of Labor Statistics. As of August 29, 2024. Analysis by Franklin Templeton Institute.
[5] Ibid.
[6] Texas accounted for 87% of the national rise in continuing jobless claims between the week of July 8 and July 15. US Department of Labor. Analysis by Franklin Templeton Institute.

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Stephen Dover

Stephen Dover, Head of Franklin Templeton Institute, believes that it makes sense to step back from current conditions and assess the medium-term outlook for growth, earnings, interest rates and valuations, and to consider secular forces likely to produce solid investment returns over time.

He believes that too often, investors are preoccupied with the near term.

“That can lead to misjudgements, like recency bias, which assigns undue importance to current events. Obsessing over the near term may also obscure arising investment themes. And it can result in an underestimation of the fundamentals that anchor asset prices over time.

“When it comes to wealth enhancement, the longer run is decisive. Many studies have shown that the strategic asset allocation decision, and adherence to it, determines the lion’s share of a portfolio returns and risk over time.

“It therefore makes sense to step back from current conditions,” says Dover.

In what follows, he outlines his thinking about the next 1–3 years.

“In ensuing notes, we will delve more deeply into various aspects, examining more closely where medium-term opportunity and risk reside across global capital markets. We begin by outlining the fundamental backdrop for global economic activity and inflation, which determine the trajectories for short- and long-term interest rates, as well as the sustainable growth of corporate profits. We then consider valuations and how they may impact returns across asset classes. We conclude by identifying themes that we believe could produce superior returns over time, even regardless of the global business cycle.”

In this analysis, he covers:

• Global growth and inflation
• Risks to the view
• Equity valuations and continuity
• Fixed income valuations
• Secular themes
• Investment conclusions

Read the report.

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As a result, the US equity market has substantially outperformed Japan, Europe and emerging markets as a whole.

Chris Galipeau, Senior Market Strategist and Lukasz Kalwak, Senior Analyst at the Franklin Templeton Institute note (in the attached detailed paper) noted “The global earnings situation is changing. US earnings should still be strong, but we think emerging markets offer even better performance potential. Equities in Japan and Europe also look stronger to us than they have in the past 15 years.”

“Valuations matter along with earnings. While earnings drive stock prices over time, prices fluctuate as estimated earnings valuations oscillate for extended periods. In our view, long-term investors should consider various valuation methods as part of their toolkit.

“Another valuation method to consider is the price of stocks relative to earnings growth, which is known as the PEG ratio. We can use this measurement for both historical and forward-looking comparisons. We have compared the current price relative to the average earnings growth of the past 10 years, as well as the price relative to expected earnings for 2024, 2025 and 2026.2 In the historical comparison, while all markets appear to be undervalued relative to the past 10 years, the gap is the largest for emerging markets.

“Looking forward, emerging markets also appear to have the most attractive PEG ratios relative to expected earnings through 2026.

“When comparing equity opportunities, we believe investors may be well served to consider future earnings growth along with valuation measures. Based on our comparisons emerging markets, as represented by the MSCI Emerging Markets Index, show the strongest forward earnings growth combined with the lowest valuation backdrop.

“Regarding valuation, emerging markets appear undervalued, whether one considers the more traditional P/E multiple or if one also contemplates the forward price-to-earnings-growth measure (PEG ratio).”

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Kim Catechis

There is a feeling of cautious optimism in the United Kingdom ahead of the election in July, says Franklin Templeton Institute Investment Strategist Kim Catechis.

The Beatles’ George Harrison wrote “It’s All Too Much” after experimenting with the hallucinogenic drug LSD. The song was not a commercial success, says Catechis.

“But oddly enough, it captures the public mood in the United Kingdom after a torrid decade of Brexit, COVID-19, rising inflation, higher interest rates, and five prime ministers and seven chancellors in the last 14 years (with three prime ministers in the last four years).

“After 14 years in government, political parties tend to struggle in democracies, as they usually run out of ideas or are beset by internal divisions and cannot disassociate themselves from their track record. The polls ahead of the 2024 UK election have been remarkably stable over the last two years, showing the opposition Labour Party ahead of the Conservative and Unionist Party by a margin of around 20 percentage points. Prime Minister Rishi Sunak called a snap election for 4 July, catching most by surprise—and likely complicating the US ambassador’s plans for US Independence Day holiday celebrations that day!

“This election campaign is mercifully short (six weeks) but also unusual in its blandness. Both Sunak and the leader of the Labour Party are widely considered to lack charisma, which accentuates their lack of a strong agenda. The topics discussed at debates include immigration (too much of it) and public services including the National Health Service (not enough of them). The Conservatives have been talking about generational culture war issues, cutting taxes for pensioners and reintroducing national service for 18-year-olds, and appear to be trying to fend off the right-wing Reform Party with plans to deport undocumented immigrants to Rwanda. The Labour Party is being very vague on policy, probably to avoid alienating the centre-ground voters.

“There is an unresolved debate to be had over the philosophy of taxation, spending priorities and structural reforms. This could have been a unique opportunity to ask voters if they want the United Kingdom to be more like the United States, with low taxation and low social spending, or the European Union (EU), with higher taxation and strong social support services, including childcare, housing and education.

“Whoever wins, the starting point is suboptimal. The economy has been barely growing, productivity has been poor since 2008, and wages have barely increased in real terms in the last 14 years.^[1] Energy-driven inflation has been tough to deal with, and higher interest rates have added to the squeeze on consumers. Public finances are stretched, and the United Kingdom’s cost of borrowing is higher because of the misjudged budget^[2] of September 2022. Higher taxes or more borrowing will be needed to finance any investment to repair public services. Besides, there is an urgent need to reinvest in its defence capabilities, increasing the financing requirements further.

“The country seems trapped in a net of weak growth, weak productivity and relatively high inequality. Yet, both main parties are ignoring the obvious point—that all remedies will require financing via debt or increased taxes—or both. In the United Kingdom, the income tax levels range between 20 percent and 45 percent. The capital gains tax levels range between 10 percent and 28 percent. It seems likely that these might be harmonised, leading to a reduction in switching income to investment (in property for example) to minimise tax paid. Estimates suggest harmonisation could raise around £16 billion^[3] per year and given that only around 3%^[4] of UK adults pay this tax, it could be a politically astute move.

“There is a general market expectation that the UK economy will grow out of this predicament, but painfully slowly, unless productivity can be boosted. One of the obstacles is demographics. The workforce cannot be easily increased, because the rate of female participation in the workforce is already at 72%.^[5] In addition, the country appears to have 9.4 million^[6] economically inactive people who are between 16 and 64 years old, more than before the COVID-19 pandemic. Separately, the seasonally adjusted unemployment rate in the three months to April was up strongly, at 4.4%.^[7]

“The fiscal constraints and the productivity issues are not unique problems, and the capital markets appear to be positive about the prospect of a change of government, in the expectation that policy direction will be pro-growth, but with a cautious approach to fiscal policy. Supply-side reforms, stability of economic policy and potentially a concerted effort to smooth relations with the EU could help build confidence and facilitate trade flows. Investors appear to anticipate benefits for banks, homebuilders, and food retail, but a cloudier outlook for energy, where Labour leaders have indicated they want to extend or increase the Energy Profits Levy.

“The UK equity market is not especially cheap at a 12 month forward price-to-earnings ratio of 11.58 and its dividend yield of 3.7% is welcome, but not world-beating.^[8] Year-to-date performance suggests interest could be reviving and as inflation gradually eases, investors can likely look forward to a significant reduction in interest rates.

“The fixed income market recognises that the Labour Party must be keen to serve two terms, because the party’s project cannot be delivered in four years, so fiscal orthodoxy is virtually guaranteed. The recent uptick in unemployment and the gradual decline in inflation point to a peaking in interest rates. Further, with the low likelihood of a repeat episode of Liz Truss’ “Stranger Things.” bond investors may feel comfortable with 10 year Gilts at 4.33%.^[9]

“Sterling has enjoyed a measure of stability, gaining some ground against the euro year-to-date, as markets expect the Bank of England to cut interest rates more slowly than the European Central Bank. A “change of government, the perception of less friction in trade with the EU, and we believe the expectation of stability and orthodox policy direction could provide further support to British pound sterling this year.

“Finally, the city of London, which has been on a downturn since Brexit as jobs and transaction volumes have moved to the EU and some exciting tech companies have chosen New York for their listings, seems to be in a mood of cautious optimism. There are a handful of initial public offerings pending, after Raspberry Pi, (a British microcomputer maker valued up to £540 million), including Shein (a Singapore based Chinese fast fashion company) and DeBeers (the South African diamond giant), rumoured to be spun off by Anglo American as part of a restructuring plan.

“In a world where exchanges and economies evolve continuously, it does seem like there is a feeling of cautious optimism. It could be time to sing a later George Harrison song, “Here comes the Sun”!”

———–

Notes:
[1] Source: “Recent trends in public sector pay.” Institute for Fiscal Studies (IFS). 26 March 2024.
[2] Former Prime Minister Liz Truss and Chancellor Kwasi Kwarteng surprised with a “mini budget” based on increased borrowing and significant tax cuts; this resulted in a revolt by the capital markets, the Bank of England made the largest interest-rate increase in 27 years, and sterling hit an all-time low against the US dollar.
[3] Source: Arun Advani, Associate Professor (Economics), University of Warwick and Research Fellow, Institute for Fiscal Studies.
[4] Ibid.
[5] Source: “Women and the UK Economy.” House of Commons Library, Research Briefing. 4 March 2024.
[6] Source: Office for National Statistics (ONS), Economically inactive. As of April 2024.
[7] Source: Office for National Statistics (ONS), Unemployment rate, seasonally adjusted. As of April 2024.
[8] Source: MSCI, Macrobond, Analysis by Franklin Templeton Institute. As of 31 May 2024.
[9] Source: Macrobond as of May 31st, 2024

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Susan Gim

Franklin Templeton’s specialist investment managers provide their outlooks on Central Banks, the global economy and key asset classes for the second half of 2024. They include insights from the following firms:

Brandywine Global Investment Management expects high yield bonds to continue to benefit from an attractive yield as well as strong fundamentals and favorable supply-demand dynamics. Headquartered in Philadelphia, Brandywine Global looks beyond short-term, conventional thinking to rigorously pursue long-term value. Based in Philadelphia, it has $61 billion in assets under management (AUM) as of March 31, 2024.

ClearBridge Investments provides its views on the outlooks for both large cap growth and international growth stocks for the remainder of the year. Headquartered in New York with $187.9 billion in AUM, it is an authentic active global equity manager with a legacy dating back over 50 years.

Martin Currie, a firm that dates back to 1881 and has $20.7 billion in AUM, provides its outlooks on global emerging markets. Headquartered in Edinburgh, Scotland, Martin Currie is driven by its purpose of Investing to Improve Lives.

Western Asset Management provides its outlooks on global fixed income as well as U.S. municipal bonds. Western Asset is a globally integrated fixed income manager, sourcing ideas and investment solutions worldwide. Based in Pasadena, CA, it has $385.4 billion in AUM.

Brandywine Global: High yield bond market outlook

Bill Zox, CFA, Portfolio Manager says “The high yield asset class continues to benefit from an attractive yield around 8%, strong fundamentals and favorable supply-demand dynamics. The one metric that warrants caution – a spread over Treasuries that is near the tight end of the historic range – must be managed but is not in our view enough to offset the many positive factors. Defaults have stabilised at well below average levels since late last year. Interest coverage has stabilised at well above average levels.

“The management teams of high yield issuers have had almost two years to prepare for higher interest rates and possible recession. And, except for the lowest 10%-15% of credit quality, they have had good access to capital, not just in the high yield market but in loans, private credit, asset-backed securities and public and private equity. High yield issuers with publicly traded equities can access the convertible bond market at the same low interest rates we saw from 2020-2021 if they are willing to give up some of the upside on their stock, which may well be at a high valuation.

“Since 2022, most of the new issuance in high yield has been for refinancing. We have not seen much, if any, of the risky bond structures or financing of bad businesses that precipitated major sell-offs in prior high yield cycles. This very limited net new supply is being met with strong global demand for high yield bonds from allocators who understand these positive factors and the long history of compelling risk-adjusted returns that the asset class has delivered.

Western Asset: Global fixed income outlook

Michael Buchanan, Co-Chief Investment Officer says “The market consensus expectation is for interest rates to remain “higher for longer” due to resilient economic growth and persistent inflation, which continues to exceed the Federal Reserve’s target. This outlook suggests that any potential rate cuts by the Fed would be limited and likely not occur until the latter half of the year. However, there’s also a strong possibility that if inflation rates gradually decline, even if unevenly, it could pave the way for the Fed to eventually lower rates further, although the timing and extent of such cuts remain uncertain.

“Western Asset holds a constructive view across most fixed income sectors, encouraged by the slow but steady resolution of inflationary pressures and other challenges that arose during the Covid crisis, although geopolitical risks remain a significant concern. A peaceful navigation through these risks could lead to a more favorable outlook for fixed income markets, especially as growth is expected to slow and inflation to decline, potentially allowing the Fed to adjust its policy stance.

“We believe that this positive macroeconomic outlook promotes renewed optimism for fixed income and even suggests an “end of cash” era, arguing that cash equivalents are often the worst-performing asset class; this is supported by the evidence that fixed income investments typically outperform cash, especially when the Fed enters a policy easing cycle. Historical trends show that diversified bond portfolios can offer healthy returns even when the Fed pauses rate cuts. Moreover, fixed income offers valuable portfolio diversification benefits, as the historically negative correlation between equities and bonds has resumed after being disrupted by the high inflation environment of 2021-2022.

“We believe that in this environment, active management is critical to help investors identify attractive opportunities. Specifically, high yield credit, structured products, emerging market debt and agency mortgage-backed securities (MBS) present compelling prospects due to their attractive spreads and strong fundamentals. Additionally, we see potential in municipal bonds (munis), as historical data suggests that entering the market before the Fed initiates rate cuts has typically led to more favorable outcomes compared to investing after the initial rate reduction in a cycle.

“In summary, our outlook at Western Asset is supported by expectations of easing inflation and eventual rate cuts. This favorable environment strengthens our conviction to increase exposure to select fixed income sectors that present attractive return opportunities. We also underscore the importance of active management to nimbly position portfolios and seize compelling opportunities as they arise, in an effort to maximise returns for our clients.”

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