Time to Reset Expectations?

Franklin Templeton’s senior investment leaders recently sat down for a Q&A discussing the opportunities and risks they’re currently seeing in markets, with three major themes in mind:

• Unwinding Quantitative Easing—Will It Unwind the Markets?
• Equity Market Stability or Volatility—How Should Investors Prepare?
• The Elephant in the Room – How are Political Risks Influencing Investing?

Christopher Molumphy, Head of Fixed Income and Dr. Michael Hasenstab, CIO, Templeton Global Macro share their thoughts on shifting central bank policies may bring.

Dr. Michael Hasenstab: 

There has been a lot of focus on the speed and extent of interest-rate hikes out of the US Federal Reserve (Fed), but I think there hasn’t been enough focus on what happens when the central bank starts to unwind its balance sheet. I think the United States will be the first central bank to unwind, with Europe following suit at some point.

Christopher Molumphy: 

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The Fed started with a balance sheet of less than $1 trillion, and now it’s up to $4.5 trillion, so it has some work to do to unwind it. I think the Fed has done a reasonably good job recently of trying to telegraph its intentions. It’s a big action in front of us, and there are a lot of things that could go wrong. We have to be ready for that.

Dr. Michael Hasenstab: 

I believe US interest rates need to go higher. The US now has full employment, economic growth is at or above potential and the output gap has closed. All of these factors point to a 10-year US Treasury yield that should be higher than 2%.

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Stephen Dover, Head of Equities and Ed Perks, CIO, Multi-Asset Solutions share their thoughts on how investors should think about risk in equity markets right now.

Ed Perks: I think the low market volatility we have seen likely has had some influence on the relatively strong business and consumer confidence that exists today. For investors, it has enabled more of a focus on fundamentals, which have been strong. However, this period of relatively low—I wouldn’t say unprecedented, but I would say relatively low—volatility is unlikely to persist.

Stephen Dover: Corporate earnings have not only been strong but also coordinated around the world, which is the first time that’s happened in quite a while. Earnings continue to surprise on the upside. I think as long as interest rates rise on a measured basis, that’s probably priced into the market at this point. The environment is relatively benign, and markets are relatively calm, but the risk is that if there’s a shock, I think the markets are probably not really prepared.

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Our investment leaders also discuss how exogenous political risks are influencing their investment thesis.

Chris Molumphy: I think the markets have done a reasonably good job looking through some of these non-fundamental bouts of volatility—political, geopolitical and otherwise—and have held up reasonably well. Exogenous risks make things a bit more difficult. What we try to do is determine whether near-term risks are going to impact longer-term fundamentals. More often than not, they tend to be more transitory in nature and can create buying opportunities.

Ed Perks: As investors ourselves, ultimately, we need to access as broad and strong a set of building blocks for our portfolios as possible. Generally, with many markets at different levels of valuation in terms of attractiveness, investors increasingly want to be very specific with the exposures they might be getting in particular asset classes.

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Visit our Global Investment Outlook page for additional commentary and videos from our senior leaders sharing their perspectives on how investors should prepare for what’s ahead.