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Staying nimble amid an uncertain outlook FRANKLIN TEMPLETON THINKSTM GLOBAL INVESTMENT OUTLOOK OCTOBER 2019 Recession: Separating fact from fears The consequences of monetary policy Geopolitical risks take center stage Potential shocks
Bouts of volatility hit markets across the globe in Featured senior investment leaders
the third quarter of 2019 amid continued
Sonal Desai, Ph.D.
uncertainties about global growth and trade. Central Chief Investment Officer,
banks took notice, with the US Federal Reserve Franklin Templeton Fixed Income
easing interest rates for the first time in more than
a decade and the European Central Bank also Stephen H. Dover, CFA
cutting rates and reintroducing quantitative easing. Head of Equities
Against this backdrop, our senior investment
leaders discuss why they do not see a recession in Michael Hasenstab, Ph.D.
the near term, but are taking a cautious and Chief Investment Officer,
Templeton Global Macro
nimble approach.
Discussion topics within: Edward D. Perks, CFA
Chief Investment Officer,
• Recession: Separating fact from fears Franklin Templeton
Multi-Asset Solutions
• The consequences of monetary policy
• Geopolitical risks take center stage
• Potential shocks
WHAT ARE THE RISKS?
All investments involve risks, including possible loss of principal. Bond prices generally move in the opposite direction
of interest rates. Thus, as the prices of bonds adjust to a rise in interest rates, the share price may decline. Investments
in foreign securities involve special risks including currency fluctuations, economic instability and political develop-
ments. Investments in emerging market countries involve heightened risks related to the same factors, in addition to
those associated with these markets’ smaller size, lesser liquidity and lack of established legal, political, business and
social frameworks to support securities markets. Such investments could experience significant price volatility in any
given year. High yields reflect the higher credit risk associated with these lower-rated securities and, in some cases, the
lower market prices for these instruments. Interest rate movements may affect the share price and yield. Stock prices
fluctuate, sometimes rapidly and dramatically, due to factors affecting individual companies, particular industries or
sectors, or general market conditions. Treasuries, if held to maturity, offer a fixed rate of return and fixed principal
value; their interest payments and principal are guaranteed.
Q: Recession worries dominated media headlines recently.
How do you respond to these concerns?
Ed Perks SERVICE ECONOMY REMAINS IN EXPANSION, WHILE MANUFACTURING DECLINES
I think we need to look at what causes Exhibit 1: Global Purchasing Managers’ Index (PMI)
September 2016–August 2019
a recession. When an economy is
Index
overheating, monetary policy plays a
55
traditional role to cool it down. This
Expanding
business cycle feels a bit different.
54
We don’t have those classic signs of
overheating, but we have a lot of
53
moves that seem to be preemptive—
whether that’s US fiscal policy stimulus
52
or actions of central banks globally.
The big issue right now is trade policy 51
uncertainty. Not just from the stand-
point of the impact on the real economy, 50
but maybe more importantly, the Declining
question of how the situation could be 49
resolved, or how much more could it Sep 2016 2017 2018 2019 Aug 2019
escalate. The uncertainty about trade Manufacturing PMI Service PMI
has put a bit of a lid on the outlook for Sources: Franklin Templeton Capital Market Insights Group, IHS Markit Global Services/Manufacturing PMI, Macrobond.
equities. That said, I would note US Important data provider notices and terms available at www.franklintempletondatasources.com.
equities are actually near all-time highs. The Global Sector Purchasing Managers’ Index (PMI) tracks variables such as sales, employment, inventories and prices.
A reading above 50 indicates that the sector is generally expanding; below 50 indicates that it is generally declining.
Stephen Dover US EARNINGS GROWTH EXPECTED TO SLOW IN MOST SECTORS
I think it’s important to point out the Exhibit 2: Year-over-year US corporate earnings-per share (EPS) growth (%)
global economy has changed over As of August 31, 2019
the past few decades. Gross domestic 50%
product growth is less manufacturing-
40%
driven and more service-driven—and
this is the case not only in most 30%
developed countries but in a number 20%
of emerging markets, too. Globally,
one can argue the manufacturing side 10%
is currently in recession, but the 0
service economy is not (see exhibit 1).
-10%
Meanwhile, earnings growth hasn’t -20%
been what we had hoped for earlier in
S&P 500
Energy
Discretionary
Industrials
Telecomm
Financials
Materials
Information
Technology
Health Care
Utilities
Staples
Real Estate
the year, so there’s also some talk of an
earnings recession in the sense that
earnings growth has slowed compared
Next 12 months, year-over-year EPS growth Last 12 months, year-over-year EPS growth
with recent years. While predictions still
Sources: Franklin Templeton Capital Market Insights Group, S&P Dow Jones Indices, FactSet. Important data provider
look pretty positive for 2020, earnings
notices and terms available at www.franklintepletondatasources.com. For illustrative purposes only and not reflective
could certainly come down a bit (see of the performance or portfolio composition of any Franklin Templeton fund.
exhibit 2). We are still relatively positive Indexes are unmanaged and one cannot directly invest in an index. They do not include fees, expenses or sales charges.
on our outlook for equities—corporate There is no assurances that any estimate, forecast or projection will be realized.
profits remain high, even if their growth
Staying nimble amid an uncertain outlook 3
is diminishing a bit. We still see a lot of than $800 billion in 2018 in the United Sonal Desai
potential opportunities right now States.1 I think it’s interesting to look at When I look at EPS growth because of
but recognize that fears about a reces- the difference between the absolute buybacks, it brings us to a discussion
sion and negative news can indeed earnings of all companies and earnings of an unusual quantity of liquidity.
be self-fulfilling prophecies. When busi- per share (EPS), which represent a It’s essentially financial engineering.
nesses are uncertain, they tend to company’s profit divided by shares it But what I find interesting is we are
pull back. has outstanding. Absolute earnings really talking about a possible earnings
growth has been less than earnings per recession—not a real economic
Ed Perks share growth due to share buybacks, recession. I absolutely agree that firms
particularly in the United States. could start becoming a lot less
I think we should be asking ourselves:
Buybacks can create distortions in the confident about the outlook and that
“What are the forces that have been
equity market, particularly in terms of can impact investment.
holding up market performance?” Going
valuations. Stock prices tend to appre-
back to the risk of recession versus the
ciate more than they would if there were On the other hand, we continue to see
fear, if uncertainty rises to a degree
no buybacks, and at least in the United very robust wage growth (see exhibit 3).
where corporations really start to pull
States, buybacks have really been So, I would agree that we might see
back on capital expenditures, that
propelling the market. Buybacks can be an earnings recession play out if we
could be a self-fulfilling mechanism that
considered a form of demand for equi- aren’t already, but I’m not so sure it’s
does slow growth.
ties—since they involve a purchase translating near term into a recession in
of shares. Lastly, money from buybacks the real economy in the United States.
Stephen Dover that is returned to shareholders wouldn’t
One of those sustaining forces is be available to investing back into the
buybacks—which hit a record of more business to fuel growth.
STRONG US SAVINGS RATE AND WAGE GROWTH TRENDS WITHOUT DEFLATION
Exhibit 3: US Bureau of Economic Analysis
January 1990–April 2019
12.5%
10.0%
7.5%
5.0%
2.5%
0.0%
-2.5%
-5.0%
1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 2016 Apr
2019
Savings Rate (% Disposable Income) Nominal Wage Growth (% YoY) Core-PCE (% YoY) Recession period
Sources: FTI Fixed Income Research, US Bureau of Economic Analysis (BEA), Macrobond.
The core Personal Consumption Expenditures (PCE) excludes food and energy prices from the index.
1. Source: S&P Global press release, March 25, 2019, “S&P 500 Q4 2018 Buybacks Set 4th Consecutive Quarterly Record at $223 Billion; 2018 Sets Record $806 Billion.”
4 Staying nimble amid an uncertain outlook
Q: What’s your view of monetary policy globally—and the
implications for investors?
Michael Hasenstab against this threat seems strange to me. tariffs, at some stage, we have to
If we were to look back 10 years ago, With record low US unemployment, actually consider a rise in inflation.
the thought that central banks the Fed seems to be anticipating a
would be cutting interest rates when deflationary situation that doesn’t seem Stephen Dover
wages were going up, when there to exist, and effectively keeps pushing
From the equity point of view, while we
is record-low unemployment, decent investors towards riskier, less liquid
see many opportunities globally in
economic growth and strong budget assets. If we look at wage growth
markets, we are also quite cautious.
deficits, would seem pretty unconven- combined with the impact of US-China
tional. Quantitative easing programs
in the wake of the 2008–2009 global NEGATIVE-YIELDING DEBT IMPACTING MANY COUNTRIES
financial crisis were unconventional— Exhibit 4: Top 10 countries with negative-yielding debt
As of August 30, 2019
and they worked really well. So, central
Country
banks across the globe are now Par Outstanding ($Bil) Sweden
doubling down on unconventional policy $317
during a different fundamental Netherlands
$678
backdrop—one that is much stronger—
Belgium Germany Japan
and we just don’t know what some $358 $1,836 $6,904
France
of the results of this policy experiment Switzerland $2,141
Austria
will be. The idea of negative interest $228 $268
rates has become very normal (see Spain
$794
exhibit 4). I think we have to question Italy
$435
that thinking. Negative rates can
be counterproductive. Sources: Franklin Templeton Capital Market Insights Group, Bloomberg Barclays Negative Yielding Debt Index. Important
data provider notices and terms available at www.franklintempletondatasources.com.
When you have a lot of savers facing a Bloomberg Barclays Negative Yielding Debt Index includes securities in treasury, government-related, corporate and
negative return on their bank accounts securitized sectors. Indexes are unmanaged and one cannot directly invest in an index. They do not include fees,
and their savings, they tend to save expenses or sales charges.
even more and spend less and so it’s
counterproductive. We need to consider EARNINGS YIELD IS HIGHER THAN THE YIELD ON FIXED INCOME
whether these exceptionally low interest Exhibit 5: Global earnings yield and government bond yield
August 2001–August 2019
rates are artificially pushing investors
seeking better yields into riskier assets Yield %
14%
at higher valuations and perhaps less
12%
liquidity. So, I think policy decisions are
where the biggest risks lie because they 10%
are creating some distortions, which 8%
could trigger a recession. 6%
4%
Sonal Desai 2%
0%
I don’t see how it can end well when
Aug-01 2003 2007 2011 2015 Aug-19
central banks—particularly the US
Earnings Yield, MSCI EAFE Yield to Maturity—Bloomberg Barclays Global Aggregate Government Index
Federal Reserve (Fed)—seem to be
guarding against a perceived threat of Sources: Franklin Templeton Capital Market Insights Group, MSCI, Bloomberg, Macrobond. Important data provider notices
and terms available at www.franklintempletondatasources.com. For illustrative purposes only and not reflective of the
deflation. There’s absolutely no sign of performance or portfolio composition of any Franklin Templeton fund.
deflation anywhere in the United States, The MSCI Europe, Australasia and Far East (EAFE) index captures large- and mid-cap representation across 21 developed
so this complete focus on guarding market countries. Indexes are unmanaged and one cannot directly invest in an index. They do not include fees, expenses
or sales charges. There is no assurances that any estimate, forecast or projection will be realized. Past performance is
not an indicator or guarantee of future results.
Staying nimble amid an uncertain outlook 5I think equities, at this point, are a yield costs as well. We have seen a real access to capital, so they can sustain
opportunity. The yield on earnings is pickup starting to happen in credit share buybacks.
still much higher than the yield on markets; companies have been able to
fixed income (see exhibit 5). access longer-term capital at incredibly As multi-asset investors, when we look
low rates. This ties back into our at negative sovereign rates around the
discussion about the bigger positive world, and very low absolute yields in
Ed Perks the broad range of fixed income sectors
drivers for equities—namely share
As central bank activity continues to in the United States, at some point
repurchase activity. While we may see a
push investors into riskier assets, the we have to ask where the alternatives
slowdown in earnings growth going
broader drift downwards in global rates are. It’s a challenging time for investors.
forward, corporations do still have
has implications for corporate borrowing
Q: Geopolitical risks are taking center stage. How has the
investment landscape changed as a result?
Michael Hasenstab capital when people panic. We have Sonal Desai
When we have geopolitical risks such as been de-risking some of our exposure in To add to Michael’s comments, there
the current trade frictions between emerging markets. We are still finding has to be a little expectation manage-
the United States and China, the splin- some select opportunities, but are ment on the part of investors in the
tering of populations, the growing taking a more conservative approach sense that we are in a world where fixed
social divide and the rise of populist and paring back a bit. income rates are incredibly low. It’s
economic agendas, we have seen difficult—and unrealistic—to expect to
Bottom line, I think it’s time for inves-
a resulting rise in deficit spending. generate the type of returns people have
tors to think about what worked for
become accustomed to without some
In fact, a lot of international organiza- the last 10 years and realize it probably
risk and volatility. That’s a bit of a sea
tions—including the International isn’t going to keep working the same
change. For many years, people became
Monetary Fund—have warned that way going forward. We think it’s
much more comfortable with the idea
even major countries that had been important for investors to be nimble—
that yields would just go down, that
fiscally sound now are running out of that means being actively positioned
there is no other direction for them to
fiscal room. for greater risks.
So, when an economic downturn does SOUTH KOREAN EQUITY PRICES AT A RELATIVE LOW, MAY OFFER OPPORTUNITY
eventually come, our question is, what Exhibit 6: South Korean equity index, trailing price-to-earnings
policy tools are left to restart growth? 1994–2019
Governments have already spent money P/E Ratio
and central banks have already lowered 30 Nov 1998 / 19.75 Sep 1999 / 24.391 Feb 2011 / 15.867
interest rates preemptively to react 25
May 1997 / 18.904
to a potential shock that hasn’t actually 20
materialized, so policymakers are 15
running out of tools. 8.65
10
5
We’re looking at the world differently
0
today than we have over the past 10
1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 2016 2019
years. We are favoring what the market
Sources: Franklin Templeton Capital Market Insights Group, MSCI Korea Large Cap Value Index, Macrobond. Important data
generally considers “safe-haven” assets. provider notices and terms available at www.franklintempletondatasources.com.
For example, places like Japan or Trailing price-to-earnings measures the current share price relative to the total EPS earnings over the past 12 months.
Scandinavia—which have current The price-earnings (P/E) ratio is a valuation multiple defined as market price per share divided by annual earnings
per share (EPS).
account surpluses and tend to receive
Indexes are unmanaged and one cannot directly invest in an index. They do not include fees, expenses or sales charges.
There is no assurances that any estimate, forecast or projection will be realized. Past performance is not an indicator
or guarantee of future results.
6 Staying nimble amid an uncertain outlookgo, and valuations just got more and opportunities. For example, around There is also a lot of concern about
more stretched. Because investors are Brexit and the UK market, there are China and slowing growth in its
in that frame of mind, at a time of some companies that have adjusted or economy. I’ve pounded the table for a
stretched valuations and with height- will be able to adjust, and should do long time about how global equity inves-
ened geopolitical risk, I think volatility well regardless of what happens. There tors really need to look at China in a
has to go up. is also a lot of fear around global trade different way than they have in the past,
issues—and some of this fear may be because its economy has shifted to a
Stephen Dover overdone. For example, the South different model—one that is more
Korean equity market has suffered from service-based. China’s size and influ-
I’m always amazed at businesses’ ability
some trade-related fallout, and is the ence are huge in the global economy,
to adjust to various environments, but
cheapest it’s probably been in about and we think investors should not
what businesses can’t adjust to is
20 years. So, we see some select ignore it.
uncertainty. That said, geopolitical risks
opportunity in South Korean equities
or changes can also lead to new
as well (see exhibit 6).
Q:
Ed Perks
What are the issues or potential shocks that worry you most?
Some of the political candidates have Michael Hasenstab
The one potential shock or variable stated they favor policies which Whether it’s stretched valuations, the
that I think could have a real impact on would negatively impact the profitability lack of policy tools that central banks
financial markets—and change our of companies; that would have a and ministries of finance have to fight
outlook for equities—would be a pretty profound effect on equity an inevitable downdraft, or less liquidity
deterioration in consumer sentiment. markets. If there is a shock, we believe in markets because people are buying
Certainly, there are a lot of things it could manifest as a shortage of riskier assets, we see these conditions
underpinning the consumer, which has market liquidity. That’s something to be as a mounting pile of dry kindling.
been a bastion of strength in the US concerned about—as active investors, We don’t know what the spark will be,
and global economy. We continue to see we continuously monitor liquidity within but we think it’s time to buy more
job and wage growth. But could our portfolios on a stock-by-stock basis. fire extinguishers. There is growing
trade-related uncertainty weigh on political division globally, and a lack of
consumer and business sentiment to a Sonal Desai consensus. In Europe’s case, there is a
degree that causes big cracks? Many of the risks we are talking about lack of European identity and with
That’s a concern that would challenge are, in some regard, related to social that comes an inability to work together
the landscape and how assets are populism and political instability. when needed. It’s far left, and far
allocated, as well as the performance of The impact is that there are what I right—with little in between. I think it’s
different asset classes going forward. consider to be some scary ideas out certainly prudent to be building a more
there. For example, the idea of Modern cautious portfolio, because when we
Stephen Dover Monetary Theory essentially says the look to the horizon, it’s hard to imagine
central bank should and can keep a period of geopolitical stability
There are a lot of geopolitical risks
printing money to finance deficits, and coming—in the near term at least.
coming up that could create even more
uncertainty. At a minimum, between this is supposed to finance universal
now and November of next year, there is basic income or anything else. This Ed Perks
expected to be a lot of volatility over approach is a slippery slope, in my view. I think that certainly tallies with the
political developments around the If we see country after country moving theme of taking an active approach in a
world—including a US presidential elec- in this direction of what I can only period of potentially high volatility.
tion. I believe that’s an uncertainty consider as sheer recklessness, that to
companies don’t know how to deal with. me is a huge worry.
Staying nimble amid an uncertain outlook 7IMPORTANT LEGAL INFORMATION This material is intended to be of general interest only and should not be construed as individual investment advice or a recommendation or solicitation to buy, sell or hold any security or to adopt any investment strategy. It does not constitute legal or tax advice. The views expressed are those of the investment manager and the comments, opinions and analyses are rendered as at publication date and may change without notice. The information provided in this material is not intended as a complete analysis of every material fact regarding any country, region or market. All investments involve risks, including possible loss of principal. Data from third party sources may have been used in the preparation of this material and Franklin Templeton Investments (“FTI”) has not independently verified, validated or audited such data. 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