INFLATION could feature prominently in many economies, especially the United States, in the coming days amid rising global commodity prices and global economic recovery from the fallout from Covid -19.
The question is whether this will only be a short-term cyclical peak through 2022 or a secular change in the longer term.
Such a debate, as Franklin Templeton points out, has implications for long-term interest rates and, therefore, for investors’ portfolios. In general, market opinion remains mixed.
However, the fund management believes that while inflation could occur in the short term, it is not likely to persist or reach levels that would cause stagflation.
The group therefore expects the prolonged low interest rate environment to continue.
Against this backdrop, Stephen Dover, chief markets strategist at Franklin Templeton (pictured), said fixed income should remain a vital part of investors’ portfolios.
Indeed, fixed income instruments such as government and corporate bonds and debt securities can provide portfolios with diversification and ballast.
“Given the current low interest rate environment, as well as high levels of uncertainty – not only around Covid-19, but also regarding US-China trade, Brexit and tensions in the Middle East – Fixed income securities can play a more vital role than ever for âportfolioâ investors, explains Franklin Templeton in his recent note to clients.
âDue to its negative correlation with many risky assets, fixed income securities can provide portfolios not only with diversification, but also with ballast,â he adds.
According to Dover, the group sees opportunities in high yield instruments and bank loans, as these potentially offer less sensitivity to rising interest rates.
While the group does not see a large margin for capital appreciation, in a context of tightening spreads, in high yield credit, it sees an attractive yield advantage over other fixed income sectors due to the continuous improvement of fundamentals and valuations. Even so, stock selection will remain critical.
âHistorically, high yield credit does better when inflation returns to below average levels, which will likely be the case this year,â said Franklin Templeton.
“We continue to position ourselves for a ‘reopening of trade’ and favor certain cyclical industries, including airlines, cruise lines and certain retail segments, complemented by better quality bias in lesser sub-sectors. cyclicals providing ballast in our portfolios, âhe adds.
As for bank credit instruments, he points out, current spreads are quite attractive, given the fact that the sector significantly underperformed high yield last year.
He sees emerging market debt as attractive as global economies continue to reopen and recover.
Overall, according to Franklin Templeton, emerging markets, led by Asia, have remained relatively resilient, having successfully adapted or suppressed the virus.
âThere are significant opportunities in emerging markets today, particularly in Asia, but geopolitical risks are worth watching,â says Dover.
He notes that given the return to growth of world economies, the group’s strategy is ârisk onâ in general.
Although stock market valuations appear strained, the group continues to see opportunities in equity investments, particularly in companies at the forefront of change which are expected to benefit from the economic expansion and resilience of emerging markets, particularly in Asia. .
âAs global stocks are trading near record highs, many investors are questioning the potential for continued gains.
“While reasonable arguments can be made that stock market valuations – particularly in certain sectors – could be defined as overvalued or ‘foamy’ from historical levels, our managers generally continue to see opportunities for the markets fellows continue to appreciate, âFranklin Templeton said. .
âOur equity managers have an eye on the sectors of the market which have been transformed by the pandemic and which may continue to be at the forefront of change,â he adds.
He is optimistic about the potential of a number of software names that support digital transformation; technological catalysts for electric vehicles and solar energy; and online dating platforms that have filled the void resulting from a lack of social interaction.
âIn the long run, we believe that innovation drives wealth creation in the economy and that investing in innovation offers a high probability of outperforming the market over a full cycle – around three to five years,â Franklin says. Templeton.
“Even after the strong performance of last year, we continue to believe that we are living in a very rich context to invest in innovation, as many quiet advances are becoming economically viable in today’s economy,” adds he does.
While the past few months have seen a shift towards value-driven, cyclical names as economies rebound from the Covid-19 crisis, Franklin Templeton says he continues to see opportunities in many high growth companies.
He argues that the discounted cash flow methodology is the best way to determine the intrinsic value of a business, noting that standard multiples do not incorporate growth.