Global Investment Committee Allocation Views

Transcription

1 January 11, 2013 Investment Team Update 1 August 2016 Global Investment Committee Allocation Views PERSPECTIVE FROM FRANKLIN TEMPLETON SOLUTIONS This investment team update describes the views of the Franklin Templeton Solutions (FT Solutions) Global Investment Committee (GIC) an experienced team of investment professionals who specialize in equities, fixed income, cross asset and absolute return investments. The committee meets regularly to share multiple viewpoints, debate implications and assess risks. This process generates key investment themes, which can be expressed in a variety of portfolios that FT Solutions offers to clients. The text below describes the views of the FT Solutions GIC as at the date of this publication. These views are for general information only, are subject to change, apply solely to FT Solutions strategies and are not representative of the views or strategies of other Franklin Templeton investment groups. Executive Summary as at 1 August 2016 On a main asset class level, we held a neutral view of corporate bonds, government bonds and alternatives. We held a modestly negative view of equities and a modestly favorable view of cash. Although global leading economic indicators mostly imply to us a low but positive growth environment, the recent narrowing in the breadth of earnings revisions and downward-trending profit margins were bearish for equity returns. However, liquidity conditions have strengthened over the past month. Our preference is for assets we view as having the most attractive relative valuations, such as emerging-market Asian equities, US Treasury Inflation-Protected Securities (TIPS) and Australian government bonds. We remain bearish on assets that we find the most overvalued, such as developed-market government bonds outside the United States, specifically German Bunds. We favor hedge funds, which have historically had strong, positive recoveries following drawdown periods. Our view on commodities remained neutral, balancing limited spare capacity with high product inventories in crude oil, which we view as bullish and bearish indicators, respectively. Asset Class Preference* Major Themes That Frame Our Tactical Asset Allocation 1. Unsynchronized Global Economic Recovery: Divergence in regional growth trends has created multi-asset investment opportunities and is likely to contribute to periods of volatility, in our view. 2. Continued Accommodative Monetary Policy: Low short-term interest rates and record liquidity injections by multiple central banks may continue, despite a potential decrease in efficacy. Central banks may find little political palatability for expanding these policies, but we believe Brexit has motivated the Bank of England to ease its monetary policy, seeking to avoid a potential financial crisis. *Based on our analysis of market factors. 3. Low and Rising Inflation: We expect inflation to slowly normalize, even if commodity prices trend sideways. Tight labor markets in major developedmarket economies, such as the United States, have historically provided a tailwind for inflation. All information presented herein represents solely the general views of the FT Solutions GIC as at the date of this publication and is for illustrative purposes only. Any statements about strategy positioning are as at 1 August 2016 and are subject to change without notice. The positioning of a specific portfolio may differ from the information presented herein due to various factors, including, but not limited to, allocations from the core portfolio and specific investment objectives, guidelines, strategy and restrictions of a portfolio. Not intended as investment advice or an investment recommendation. There is no assurance any forecast, projection or estimate will be realized.

2 Current Convictions from the FT Solutions GIC Asset Class (-) N (+) Our Viewpoint MAIN ASSET CLASSES Equities Corporate Bonds Government Bonds Alternatives Valuations priced in strong economic, earnings rebounds; not our base case scenario. Dovish global central bank policy supports equities, but market may question efficacy of unconventional monetary policy. Financial conditions, asset price trend technical indicators improved. Earnings breadth, equity valuations relative to history, trading sentiment unfavorable. Neutral high yield, slightly favorable investment-grade bonds. Relative valuations favor corporate bonds over equities. Carry over US Treasuries may lead to healthy performance potential. Corporate fundamentals appear vulnerable. Developed-market sovereign bond yields offer little value, in our view. Prefer TIPS due to attractive valuations, strong technical indicators, excessively bearish market inflation outlook, strong employment indicators, potential wage gains. Hedge funds historically have had strong recoveries following drawdown periods. Favor hedge funds due to higher expectations for market volatility, falling implied equity correlations. Neutral outlook on commodities. Cash We have a slightly defensive outlook on the overall asset classes, which led us to favor cash. Developed Economic fundamentals deteriorated due to lower retail sales. Valuations increased. Corporate fundamentals improved due to revenue, earnings growth and revisions. Valuations, corporate fundamentals unattractive relative to history. EQUITY REGIONS FIXED INCOME SECTORS ALTERNATIVE INVESTMENTS United States EMU Japan United Kingdom Canada Pacific ex Japan Emerging Asia Latin America EMEA DM Sovereign Bonds Investment Grade High Yield Inflation Protected EM Debt Hedge Funds Commodities REITs Corporate, economic fundamentals slightly improving, due to economic surprises, retail sales, revenue growth, upward earnings revisions. Money growth improved. Valuations stretched relative to history. US equities no longer oversold. Economic data slightly deteriorated but remained encouraging due to improved economic surprises. Industrial production, retail sales deteriorated but modestly strong relative to history. Corporate fundamentals and valuations are unattractive relative to history, each have improved over the past three months. Supportive monetary policy. Equities appear oversold. Corporate fundamentals weak relative to history and deteriorated, due to revenue growth; profit margins are strong relative to history. Economic data muted but surprised to the upside. Valuations increased, but slightly inexpensive relative to history. Money growth and monetary policy supportive. Japanese equities appear oversold. Valuations increased, expensive relative to history. Corporate fundamentals unattractive relative to history due to return on equity (ROE), profit margins. Revenue, earnings improved. Supportive monetary policy. Equities appear oversold. Economic data deteriorated due to retail sales, but slightly favorable relative to history. Corporate fundamentals improved, but unfavorable relative to history due to ROE, profit margins. Valuations increased, expensive relative to history. Economic, corporate fundamentals improved, but both weak relative to history. Industrial production strengthened, but valuations elevated and more expensive. Neutral, balancing improved corporate fundamentals and deteriorating economic fundamentals; both are unattractive relative to history. Valuations increased but in line with history. Economic growth surprised to the downside, industrial production deteriorated, ROE and profit margins weak, earnings improved but still unattractive. EM Asia economic data stronger than Latin America and EM EMEA. Monetary policy supports EM Asia. UK revenue exposure limited. Valuations relatively more attractive in EM Asia relative to Latin America and EM EMEA; valuations were approximately one standard deviation below mean based on price-to-earnings (P/E) and price-to-book (P/B) ratios. Manufacturing data in contraction, money growth trends lower, and earnings expectations seemed excessive. Sharp declines in commodity prices suggest misleading valuations, and equities expensive in our view. UK revenue exposure high, especially in South Africa, Turkey. Sharp declines in commodity prices suggest misleading valuations, and equities were expensive, in our view. Low yields offer little value potential, and rising inflation trend may provide catalyst for higher rates, especially if stabilization in growth continues. Demand for US Treasuries should continue in the back end of the curve, driven by technical support from liability-driven investors. German Bunds appear most overvalued. The sector seems fairly valued, yields consistent with 10-year average. Yields higher than developed-market sovereign bonds. Strong demand given solid performance, despite heavy supply. Total returns vulnerable to rising interest rates. Our fair value model suggests expensive valuations. Energy default rates, erosion in corporate health, spikes in volatility may lead to weak performance potential. On a longer-term basis, sector could perform better, driven by high carry. Attractively valued. Tight labor markets, firming average hourly earnings signs of higher inflation. Services sector inflation trending up, technical indicators support TIPS breakevens. If oil prices trend higher, longer-term inflation expectations should increase. Inflation expectations were excessively pessimistic. Valuations fair compared to history, suggesting healthy performance potential. Select emerging markets appear more stable than UK and EU economic fundamentals, valuations vary across countries, which supports active management. Unsynchronized global expansion, high volatility may benefit performance. Hedge funds historically have had strong recoveries following drawdown periods. Falling implied correlations for equity indexes may also provide tailwind. Limited spare capacity and high product inventories in crude oil are bullish and bearish indicators, respectively. Financial indicators improved in emerging markets, but underlying industrial metals demand low. Valuations less attractive relative to history. However, mortgage rates remained low and housing starts picked back up. Represents month-over-month change No arrow = No change from the previous month The graphic reflects the views of the GIC regarding each asset class relative to a neutral portfolio allocation. All viewpoints reflect solely the views and opinions of the GIC. Global Investment Committee Allocation Views 2

3 Cross Asset We favor inflation-protected assets and have a cautious outlook on global equities. Developed-market government bond yields outside the United States offered little value, in our view. Instead, we favor inflation-protected assets due to what we viewed as attractive valuations and strong employment indicators that may lead to wage gains. From our perspective, growth assets such as global equities appeared to face headwinds. Markit s Global Purchasing Managers Index (PMI), which measures the economic health of the manufacturing sector, was neutral and indicated to us that global growth should remain low. Similarly, the Citi Economic Surprise Index, which measures whether economic data exceeds or falls behind economist forecasts, was also neutral, in our view. Other economic indicators reinforce our subdued outlook for global growth, such as the Organisation for Economic Co-operation and Development (OECD) consumer and manufacturing indexes, the IFO World Economic Survey and global capital expenditures, which were all underwhelming and indicated a muddle-through growth trajectory, in our analysis. Negative indicators for risk assets include reduced breadth of earnings revisions (see Chart 1), which have historically led earnings-per-share (EPS) growth expectations. Global corporate profit margins have been decreasing over the past year, while the availability of credit was decreasing and the cost of credit was increasing. On a global basis, equity valuations relative to history have been increasing (see Chart 2). Another challenge for growth assets is the potential Global Earnings Revisions Have Trended Below the 3-Month Moving Average, Which is a Bearish Indicator for Equity Performance Potential Chart 1: MSCI All Country World Index Earnings Revisions, Weekly Level and 3-Month Moving Average July 2011 July % -5% -10% -15% -20% -25% -30% -35% -40% -45% -50% 7/11 1/12 7/12 1/13 7/13 1/14 7/14 1/15 7/15 1/16 7/16 MSCI All Country World Index Earnings Revisions Breadth 3-Month Moving Average Source: Thomson Reuters Datastream. Data as at 28/7/16. Past performance does not guarantee future results. GIC Asset Class Views Equities Corporate Bonds Government Bonds Alternatives Cash N + The graphic reflects the views of the GIC regarding each asset class relative to a neutral portfolio allocation. for accommodative monetary policies from major central banks to lose some efficacy over time. The People s Bank of China's efforts to bolster near-term growth with accommodative monetary policy, such as reduced bank reserve requirements and a low interbank lending rate, are favorable for China s growth prospects in the near term, in our opinion. However, China's non-performing loan estimates have been high, and its leading economic indicators have turned down. We balance our cautious outlook on growth assets with a few bright spots. Global central bank policy continues to be accommodative, with the US Federal Reserve (Fed) delaying an increase in interest rates. Additionally, several Bloomberg Financial Conditions indexes have recently improved. The indexes track the overall level of financial stress in the bond and equity markets to help assess the availability and cost of credit. US Equity Valuations Were Elevated Relative to History Chart 2: S&P 500 P/E Ratios and 10-Year US Treasury Yields, Monthly, Excluding the Tech Bubble July 1962 June 2016 S&P 500 Index Trailing P/E (No P/E Greater than 25) y = x x x R² = % 2% 4% 6% 8% 10% 12% 14% 16% 18% 10-Year US Treasury Yield S&P 500 Index P/E ex Tech Bubble Since July 2012 Latest Source: Thomson Reuters Datastream. Data as at 30/6/16. Past performance does not guarantee future results. Global Investment Committee Allocation Views 3

4 Equities We maintained a favorable view of emerging-market (EM) Asian equities and an unfavorable view of EM Latin American equities. We introduced a negative view on EM EMEA (Europe, Middle East and Africa) equities. Money growth has slowed in emerging Asia, mostly due to China, but has trended lower in Latin America (see Chart 3). Select emerging Asian countries, such as India and Indonesia, have the flexibility to ease monetary policy and support growth, based on our analysis of policy credibility, ongoing reform and deregulation efforts. EM Asia currently has the strongest regional EM economic fundamentals, based on the Institute of International Finance Emerging Market Growth Tracker, which comprises 41 macroeconomic indicators. In light of the late-june Brexit vote, it is also worth noting that direct-listed equity revenue exposure to the United Kingdom is very limited in Asia with the exception of India, which has the second highest UK revenue exposure among EM countries. However, UK revenue exposure was noticeably higher in the EM EMEA region, with the highest UK exposure in South Africa and the third highest in Turkey. Moreover, expected EPS growth in Latin America was excessive and unsustainable, in our view. Valuations were significantly lower for emerging Asia, while Latin America was trading above historical valuation averages as at 21 July. Fear surrounding China s growth and financial system was causing weak sentiment, but valuations in emerging Asia were approximately one standard deviation below the historical mean based on both P/B and P/E ratios. Sharp profit declines over the last few years due to declining oil and commodity prices suggest to us that P/E valuations were unattractive M1 Money Growth Was Strongest in Emerging Asia, Underscoring Favorable Liquidity in the Region Chart 3: M1 Money Growth, Year-over-Year (YOY) January 2007 May % 35% 30% 25% 20% 15% 10% 5% 0% -5% 1/07 8/08 3/10 10/11 4/13 11/14 5/16 Asia Latin America EMEA Source: National Central Banks, International Monetary Fund, Thomson Reuters Datastream. Data as at 31/5/16. The M1 measure of money supply reflects the most liquid components, including coins and currency, checking accounts and demand deposits. Based on gross domestic product (GDP) purchasing power parity weights. GIC Views of Equity Regions N + Developed United States EMU Japan United Kingdom Canada Pacific ex Japan Emerging Asia Latin America EMEA EMU: European Monetary Union; EMEA: Europe, the Middle East and Africa The graphic reflects the views of the GIC regarding each asset class relative to a neutral portfolio allocation. Represents month-over-month change No arrow = No change from the previous month in Latin America (see Chart 4). Risks to our view include opaque economic data, high corporate debt levels, possible Chinese renminbi devaluation and continued capital outflows in China. The downward trend in inflation may permit the Central Bank of Brazil to ease interest rates later in 2016, but monetary policy accommodation was already priced in Brazilian equities, in our view. Brazil EPS growth could meet consensus expectations as well, which could challenge our view. While Earnings across EMs Were Weak, Earnings in Emerging Asia Were Stronger than in Emerging EMEA and Latin America Chart 4: Earnings in EM Regions, YOY Change July 2006 July 2016 LTM Earnings YOY 80% 60% 40% 20% 0% -20% -40% -60% 7/06 7/07 7/08 7/09 7/10 7/11 7/12 7/13 7/14 7/15 7/16 MSCI EM Asia Index MSCI EM Latin America Index MSCI EMEA Index Source: Thomson Reuters Datastream. Data as at 27/7/ % -18.5% -19.7% Global Investment Committee Allocation Views 4

5 Fixed Income US inflation-protected assets appeared attractive to us. From our perspective, the US Treasury market has been excessively pricing in sluggish growth and a very conservative path of interest-rate hikes in the medium term. Therefore, we view valuations for TIPS breakevens 1 as attractive (see Chart 5). However, with no immediate catalyst for the market to meet Federal Open Market Committee projections for US interest-rate increases, US Treasuries will likely continue to have a positive carry, or yield advantage, compared to cash. But medium to long term, TIPS breakevens as at 31 July appeared to us to be cheap. US employment indicators have been improving and should bode well for wage gains, in our opinion. In addition, the gap between the unemployment rate and the non-accelerating inflation rate of unemployment appears to us to have closed. In June, the United States recorded the largest job gains in eight months. Services sector inflation, excluding energy services, has been trending up, which supports TIPS breakevens. Economic data have been muted but have improved recently, and it does not appear likely to us that a US recession is imminent. Additionally, a reduction in TIPS supply is seen as a supportive technical indicator. Furthermore, we believe the Fed may err on the side of caution due to global concerns and permit inflation to overshoot. Risks to this view include large decreases in energy prices, disappointing growth and more slack in the labor market than expected. Australian government bonds appeared attractive to us based on several factors, starting with the country s economy. Weak outlooks for economic growth and inflation in Australia provided support for our view (see Chart 6). Much of this weak economic growth stems from the protracted downturn in commodities prices amid China s slowing demand. This trend has weighed on the mining sector, the primary driver of growth for the country over the past 10 years. The country s terms of trade had deteriorated in the first quarter and unemployment was increasing as at 30 June, both of which GIC Views of Fixed Income Sectors DM Sovereign Bonds Investment Grade High Yield Inflation Protected EM Debt N + DM: Developed-Market; EM: Emerging-Market The graphic reflects the views of the GIC regarding each asset class relative to a neutral portfolio allocation. attest to the country s economic malaise. In addition, recent inflation reports and 2016 forecasts were below the Reserve Bank of Australia s (RBA s) target range, the economy was operating below full capacity and wage growth was at the lowest level since the 1990s. Risks to our view include an unexpected rise in Chinese GDP, a recovery in commodity prices, and some rebalancing of the economy away from the resource sector. We have an unfavorable view of German Bunds. What we viewed as high valuations and stretched technical conditions support our view that German Bunds could face performance headwinds. We believe medium-term yields were extremely overvalued (see Chart 7), as they recently crossed the zero bound, indicating asymmetrical risk and reward. With German Bund yields negative, investors essentially have to pay the German government to hold the bonds. Many investors believe it is unlikely the European Central Bank (ECB) will buy German Bunds with a negative yield, which in our view limits a continued rally. Based on our analysis, a small rise in yields would wipe out a year s worth of carry. Technical indicators suggest to us that German Bunds have reached overvalued levels. Risks to our view include the possibility of the ECB expanding quantitative easing to purchase bonds with negative yields, eurozone growth disappointing and leading to a recession, and inflation continuing to fall in Germany. Global Investment Committee Allocation Views 5

6 TIPS Breakeven Prices Have Been More than One Standard Deviation below Average, Implying Attractive Valuations Chart 5: TIPS 10-Year Breakevens January 2000 July Australian Inflation Was Well below the Target Range Set by the RBA, and the Money Supply Has Been Decreasing, Suggesting to Us Further Easing from the RBA Chart 6: YOY Change in Inflation (CPI) and Money Supply in Australia July 2013 May % 8.5% % 2.8% 2.6% 2.4% 2.2% 2.0% 1.8% 8.0% 7.5% 7.0% 6.5% 6.0% /00 7/05 1/11 7/16 Breakeven 10, Rolling 5 Year 1 Std Dev Breakeven 10, Rolling 5 Year Average Breakeven 10, Rolling 5 Year + 1 Std Dev Breakeven 10 Source: Bloomberg, Citi. Data as at 28/7/16. Past performance does not guarantee future results. 1.6% 5.5% 1.4% 5.0% Inflation Target Rate 2% 3% 1-Year % Change of CPI (Excluding Volatile Items) Australia (LHS) 1-Year % Change of Money Supply M3 Australia (RHS) Source: Thomson Reuters Datastream. Data as at 27/5/16. Relative to US Treasuries, German Bunds Appear Expensive to Us Chart 7: German Bund Yields vs. US Treasury Yields July 1996 July % 0.5 1% 0% 0-1% % -1-3% -4% % % 10-Year German Bunds 10-Year US Treasury (LHS) Source: Bloomberg, Citi. Data as at 27/7/16. Past performance does not guarantee future results. Eurozone US Nominal GDP Growth YOY %, 1-Year Lag (RHS) Global Investment Committee Allocation Views 6

7 Alternatives We maintained a neutral view of commodities that is consistent across energy, industrial metals, precious metals and agriculture. Energy fundamentals appeared neutral to us, balancing limited spare capacity in members of the Organization of the Petroleum Exporting Countries and declines in US crude production with drilled but uncompleted wells coming back online and high product inventories. Financial indicators have improved in emerging markets in recent months, but underlying demand for industrial metals was low. Supply for industrial metals has exceeded demand with a lack of production cuts, and fiscal spending in China has decreased. Within precious metals, our fair value model for gold indicated that the precious metal was overvalued, but the commodity remains attractive to us relative to negativeyielding government bonds. We also maintained a favorable view of hedge funds. In particular, we see the most attractive opportunities in global macro strategies, specifically emerging markets and systematic, or trend-following, strategies. Historically, when hedge fund performance has improved from below-average levels, the asset class has exhibited strong performance potential over the next 12 months. Falling implied correlations for equity indexes (see Chart 8) may also provide a tailwind for hedge funds. Sharp selloffs followed by sharp rallies in credit have been providing what we view as trading opportunities for managers. In structured credit, yields appear attractive to us, but near-term technical conditions remain challenging, based on our analysis. We also believe that conditions favor disciplined relative value managers. Falling Implied Correlations Could Support Hedge Funds Chart 8: Hedge Fund Tailwind, Correlations Falling January 2016 July /16 2/16 3/16 4/16 5/16 6/16 7/16 Source: Bloomberg. Data as at 28/7/16. Past performance does not guarantee future results. Global Investment Committee Allocation Views 7

8 WHAT ARE THE RISKS? All investments involve risks, including possible loss of principal. Stock prices fluctuate, sometimes rapidly and dramatically, due to factors affecting individual companies, particular industries or sectors, or general market conditions. Bond prices generally move in the opposite direction of interest rates. Thus, as the prices of bonds in an investment portfolio adjust to a rise in interest rates, the value of the portfolio may decline. Special risks are associated with foreign investing, including currency fluctuations, economic instability and political developments. Investments in emerging markets, of which frontier markets are a subset, 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. Because these frameworks are typically even less developed in frontier markets, as well as various factors including the increased potential for extreme price volatility, illiquidity, trade barriers and exchange controls, the risks associated with emerging markets are magnified in frontier markets. Derivatives, including currency management strategies, involve costs and can create economic leverage in a portfolio which may result in significant volatility and cause the portfolio to participate in losses (as well as enable gains) on an amount that exceeds the portfolio s initial investment. A strategy may not achieve the anticipated benefits, and may realize losses, when a counterparty fails to perform as promised. Currency rates may fluctuate significantly over short periods of time and can reduce returns. Real estate securities involve special risks, such as declines in the value of real estate and increased susceptibility to adverse economic or regulatory developments affecting the sector. Investments in REITs involve additional risks; since REITs typically are invested in a limited number of projects or in a particular market segment, they are more susceptible to adverse developments affecting a single project or market segment than more broadly diversified investments. Investing in the natural resources sector involves special risks, including increased susceptibility to adverse economic and regulatory developments affecting the sector prices of such securities can be volatile, particularly over the short term. Investments in hedge funds are speculative investments, entail significant risk and are suitable only for persons who can afford to lose the entire amount of their investment. Global Investment Committee Allocation Views 8

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