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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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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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

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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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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Stephen Dover

The start of 2024 has caught many investors off guard. Resilient US growth and inflation have defied expectations, leading to higher bond yields and a surging US dollar. Equities have paused following their strong advance since October 2023.

According to Stephen Dover, Head of the Franklin Templeton Institute “A lot has happened in the last few months, underscored by significant moves in stocks, bonds, currencies and commodities. Those factors must now be considered when deploying or redeploying capital.”

The most significant market shift since the beginning of the year has been a dramatic and unanticipated rise in global bond yields. From their early January levels of 3.86%, US 10-year Treasury yields have climbed some 80 basis points to their current rate near 4.70%.

Rising Treasury yields have caused equity markets to wobble, with the S&P 500 Index down 3% from its late-March peak.^[1]

Rising US yields have also propelled the US dollar higher in the world’s foreign exchange markets. Year-to-date, the dollar is up 12% versus the Japanese yen and 4% in trade-weighted terms.^[2]

Meanwhile, crude oil prices have advanced 16% in the first four months of the year.^[3]

Dover says “Several factors have accounted for these dramatic market shifts. But what we see as most important is the combination of resilient US growth (defying expectations of a recession) and sticky US inflation (which was supposed to keep falling but has not). As a result, the Federal Reserve (Fed) has indicated that any rate cuts will come later and more gradually than had been anticipated earlier this year. The re-pricing of Fed easing has been the most important driver of rising yields, which in turn has supported the US dollar and eroded demand for equities.

“Surging oil prices also reflect better-than-expected US (and global) growth as well as heightened uncertainty about Mideast crude oil supplies. Attacks on shipping headed for the Suez Canal have forced many deliveries to take the longer route around southern Africa, adding to crude oil’s cost and supply concerns.”

The question then is: Have these changes in macroeconomic, geopolitical and market terms changed views about how to invest?

According to Dover “In some ways, yes, though in others, they have reinforced our prior convictions.

“Take bond yields and duration. We see higher bond yields as an opportunity, rather than a risk. The ongoing restraint applied by restrictive Fed policy should slow US growth and inflation. While the lags between Fed rate hikes and weaker demand have lengthened in recent years (owing to the higher fraction of household and business borrowings at longer, fixed-rate maturities), the effectiveness of monetary policy has not been blunted. As more consumers and business re-finance or borrow for the first time, they will confront some of the highest borrowing costs seen in two decades.

“Equally, inflation has only temporarily stopped falling. Seasonally, many firms raise prices early in the year, which is one reason why inflation has levelled off at rates above where the Fed can ease. Lags are also at work, for example, in insurance premiums to reflect the higher costs of autos and homes. But over time, those price pressures are likely to dissipate.

“In contrast, shelter costs (derived from house prices and rents) have become more resistant to Fed tightening. That’s because demand for housing remains strong, underpinned by solid jobs growth. Meanwhile, housing supply has been slow to respond to demand, in large part because homeowners with low-rate mortgages are reluctant to sell.

“But even sticky shelter inflation won’t likely be enough to prevent some further softening of US overall inflation later this year. Together with weakening of growth, we think the stage will be set for US bond yields to decline over the remainder of 2024.

“Accordingly, we believe longer-duration US Treasuries and high-quality corporate credits ought to deliver attractive returns through year-end. Meanwhile, credit spreads remain tight. As a result, risk-reward does not favor lower quality credits, such as high yield.”

Dover says “Recent wobbles notwithstanding, we remain committed to global equities. US corporate profits have resumed growing, after falling for much of 2023, and should benefit from the resilience of the economy, alongside solid profit margins.

“Nevertheless, some eventual slowing of US growth argues against rotation to cyclicals, smaller capitalisation, or value styles. We prefer higher-quality stocks, able to deliver earnings through the cycle while offering sustainable dividends. We continue to believe that shares of disruptive technologies and companies with dominant business models will also perform well.

“It is tempting to see value in non-US markets. However, it is also important to note that growth, earnings and inflation dynamics in Europe, Japan and many parts of the emerging complex are headwinds. Europe, for example, remains mired in economic stagnation. Emerging markets are unlikely to rebound in advance of a broader global recovery.

“Lastly, commodity prices, and in particular crude oil prices, remain a wild card, owing to the potential for conflict to interrupt supply. Seasonally, demand for gasoline and other distillates is rising. But during the second half of 2024, some deceleration of US and global growth should result in a pullback of oil and other cyclical commodity prices.”

In conclusion Dover says “Now is the time to re-evaluate portfolio positioning. In some cases, we’re inclined to change views, for example regarding US dollar strength, which is likely to persist. But in many ways our fundamental assessment about what will drive stock and bond returns remains intact.

“We see even more compelling value in duration fixed income. Earnings should support equities, albeit with leadership in defensive rather than cyclical sectors.”

———–

Notes:
[1] Source: CNBC. Indexes are unmanaged and one cannot directly invest in them. They do not include fees, expenses or sales charges.
[2] Source: St. Louis Federal Reserve. YTD through April 29, 2024.
[3] Source: CNBC. Based on YTD ICE Brent crude prices.

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Stephen Dover

The inaugural Franklin Templeton Institute Global Investment Management Survey reports that the U.S. Federal Reserve will deliver four interest rate cuts this year, in line with the four cuts predicted by the futures market and one more than the three cuts projected by the Fed’s own “dot plot.”

The survey results, revealed by Franklin Templeton, encompass the views of 300 of its senior investment professionals from different teams around the world with unique knowledge, processes and perspectives. They span the breadth of Franklin Templeton, covering public and private equity, public and private debt, real estate, digital assets, hedge funds and secondary private market investments.

“Driven by the collective wisdom of Franklin Templeton’s worldwide investment teams, the survey – which is one of the largest of its kind – is a starting point in sharing our views on the economy, equities, fixed income and alternatives,” said Stephen Dover, Chief Market Strategist and Head of the Franklin Templeton Institute.

“It aggregates the best thinking of our diverse line-up of specialist investment managers with deep expertise in their domains to help our clients navigate the markets and solve complex issues.”

Additional predictions from Survey’s four focus areas:

The economy: A global recession should be avoided

• Franklin Templeton’s investment professionals expect to see four interest rate cuts in 2024, in line with the futures market, but more than the Fed’s latest dot plot, which is projecting three cuts in 2024. This will lead to the federal funds rate ending the year at 4.30%, while the Fed dot plot shows 4.63%.

• Global growth will be slower than consensus expectations across major regions, and noticeably weaker in Europe and China.
• Inflation will continue to moderate, but at a slower pace than consensus, and will remain above central bank targets.

Equities: Flat for the year

• The S&P 500 Index will end the year at 4744, essentially flat from where it was at the beginning of the year.
• There will be 5.8% earnings growth in the U.S., significantly lower than the 9.7% expected by the market.
• Value stocks look more promising than growth stocks, and U.S. and emerging markets should be preferred over non-U.S. developed markets.

Fixed income: Driven by Fed policy, geopolitics and recession

• Two-year Treasury yields will likely decline meaningfully while 10-year yields are expected to move only modestly lower.
• Municipal bonds will continue to be a high quality, diversifying investment option with attractive tax-free yields.
• The market should favour investment grade debt due to its higher credit quality as default rates for high yield debt continue to tick higher toward their historical average.

Alternatives: Despite headlines, real estate offers interesting opportunities

• Commercial real estate presents some interesting opportunities within sectors like industrials, multifamily and life sciences; still, challenges in the office sector will persist.
• Private credit managers have filled the void created by traditional lenders, and they’re able to negotiate favorable terms within sectors like industrials, multifamily and life sciences.
• Secondary investments provide diversification across vintages, geography, industry and types of private equity.
• Within the hedge fund space, macro and market neutral strategies look attractive given elevated geopolitical risks.

The survey provides a comprehensive summation of the views of 300 of Franklin Templeton’s investment professionals who focus on both public and private markets across asset classes.

The specific forecasts within the survey reflect the average of the group; each investment team operates independently and has its own views.

Launched in January 2021, the Franklin Templeton Institute is an innovative hub for research and knowledge sharing that unlocks the firm’s competitive advantage as a source of global market insights.

Read the survey.

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Stephen Dover

Franklin Templeton, a global investment manager, says that although inflation will continue to be an issue for the next 6–12 months and the global economic recovery is uneven, there are opportunities ahead.

Stephen Dover, chief market strategist at the Franklin Templeton Institute notes “In the first half of 2023, investors faced aggressive US Federal Reserve (Fed) monetary policy tightening, consecutive quarters of falling corporate profits, two of the largest bank failures in US history, a near-default by the US federal government, and universal predictions of US and global recessions.

“With these issues in mind, I moderated a panel of our leading economists including John Bellows, Portfolio Manager, Western Asset; Sonal Desai, Chief Investment Officer, Franklin Templeton Fixed Income; Michael Hasenstab, Chief Investment Officer, Templeton Global Macro; and Francis Scotland, Director of Global Macro Research, Brandywine Global.

“The key question I wanted to address: What’s in store for investors in the second half of 2023?

“Below are my key takeaways from the discussion.

• Inflation will continue to be an issue for the next 6–12 months. There are some indicators that point to slowing inflation and the global economy entering a period of disinflation, where the rate of inflation is falling and prices are not increasing as rapidly. Failure of inflation to retreat is a risk, and core price inflation has been sticky, but the lagged effects from tighter monetary policy have yet to be fully felt. There is less risk of deflation, where prices actually fall.
• While inflation is coming down in many countries, the global economic recovery is uneven.
  • China is struggling to find sources of economic growth. An expected surge in growth did not materialize following post-COVID reopening. The Chinese government is likely to step in with more macroeconomic stimulus.
  • Supply-chain rebuilding and friend-shoring should contribute to growth opportunities in some countries. Supply chain rebuilding is leading to increased investment within Asia, particularly in countries like India and Indonesia. Other countries that should benefit include Mexico and Canada.
  • Japan benefited from recent increases in inflation after struggling with low economic growth for decades. The current inflation and growth levels created opportunities to deploy corporate cash balances. Japan also benefited from higher female participation in the labor force that prevented a labor shortage, which in turn supported growth.
• The upcoming economic data will likely provide further evidence of slowing growth and ongoing disinflation in the US. However, while markets have been anticipating a recession for some time, the strength of the US consumer will likely prevent a massive recession.
• Where will interest rates settle? There appears to be a disconnect with how fast rates will drop in the future. The financial market is pricing rate cuts with an expectation that inflation returns to pre-pandemic levels. However, we think the 10 years following the 2008 global financial crisis (GFC) were an aberration, and inflation is likely to revert to pre-GFC levels as the long-term norm (core inflation in the US averaged approximately 4% between 1958 and 2008, and just under 2% from 2009 through 2019.)
• Real interest rates are expected to continue increasing. The Fed just approved another interest rate hike and is expected to hold interest rates above 5% for several more quarters. While inflation is expected to slow or decline over this period, the result is real interest rates (nominal rates minus inflation) rising even if nominal rates do not. This creates a more positive return for investors.
• New investment opportunities Fixed income investments are resuming status as good portfolio diversifiers. Unlike 2022, where both fixed income and equities had negative returns together, there is now a low correlation between fixed income investments, equities and other risk assets.
  • Selectively increasing duration offers an attractive total return. We see neutral to shorter duration providing better risk/return profiles for the rest of 2023. The current yield levels and the expected peak in interest rates combine for a positive expected total return.
  • High-yield debt is priced attractively as investors remain cautious about the economy. Current yields are providing active investors with high returns. However, investors need to be selective as some lower-quality corporate credit is susceptible to default risk and we have concerns about credit spreads widening.
  • Emerging markets can provide diversification. Many emerging markets have demonstrated strength, partially by controlling debt issuance to a greater extent than their developed market counterparts. They also reacted quickly to bring inflation under control, raising rates ahead of the European Central Bank (ECB) and the Fed. With many emerging market bonds enjoying attractive yields, this asset class provides another source of return that is not necessarily synchronized with the rest of the world.

“While the investor experience for the last six months was extreme volatility in terms of interest rates and changing opportunities, we believe the Fed will continue to bring inflation more fully under control and might hold rates higher for longer than some expect.

“Growth opportunities vary around the world, and across sectors and maturities. Fixed income once again has a low correlation with other risk assets, providing potential diversification and increased portfolio protection.”

Read the paper.

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As active investors, we continue to evaluate its risks and opportunities.

The Medici accounting ledger developed during the 1500s advanced Europe’s economic growth—now blockchain has the potential to launch a new, global digital Renaissance, transforming financial services, supply chains, healthcare, backend offices, and more^[1] , says Stephen Dover, Chief Market Strategist, Head of Franklin Templeton Investment Institute, Franklin Templeton.

“In 2018, we identified conditions that could make blockchain a potential disruptor for several industries. As active investors, we continue to evaluate its risks and opportunities.

“Blockchain’s biggest breakthroughs are democratisation and decentralised recordkeeping to establish trust between two internet strangers without a trusted intermediary.

“Blockchain’s innovations of tokenisation and fractionalised ownership of assets could unlock access to illiquid assets and provide broader access to non-public investments.^[2]

“Blockchain could completely change how the financial services industry operates their back offices. Blockchain could also facilitate the consumer data-mining essential for marketing financial and other services,” says Dover.

He adds: “There are obstacles to blockchain-based money.

“Current blockchain technology can manage about five transactions per second whereas credit cards can handle over 1,500 transactions per second. Many experts believe that transaction-processing gaps will evolve and widen, the flip side of blockchain’s appealing, more secure platform.

“China is rapidly moving its currency, the renminbi, toward a central bank digital currency (CBDC). CBDCs allow for greater prevention of fraud or crime, enable instantaneous international transactions, reduce transaction costs, permit greater financial inclusion, and aid the provision of direct fiscal stimulus to individuals. China’s CBDC could accelerate the decline of the US dollar as the world’s leading reserve currency.

“The US lags behind China in blockchain infrastructure and security. President Joe Biden’s infrastructure proposals include securing US blockchain infrastructure.

“Blockchain’s story may sound familiar as its evolution and cycles parallel the internet. Each were dismissed by critics, yet both have potential to unlock seemingly limitless innovation,”  says Dover.

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[1]  National Institutes of Health, Applications of blockchain in ensuring the security and privacy of electronic health record systems: A survey, July 15, 2020.
[2] Seeking Alpha, Franklin Resources, Inc. (BEN) CEO Jenny Johnson on Q2 2021 Results—Earnings Call Transcript, May 4, 2021.

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