Franklin Templeton, one of the world’s ten largest asset managers, this week outlined its views on investing at a time that inflation threatens to undermine economic growth. Investors who haven’t already done so need to adapt their portfolios to take account of the new inflation-fighting interest rate environment, at least in the short term. Underpinning its investment outlook is the expectation of more balanced monetary policy risks later this year.
The first Fed 75 basis point interest rate increase since 1994 has taken place on Wednesday. There has already been some guidance towards a further 75 basis point Fed hike in July, pointed out John L. Bellows, portfolio manager focussing on broad market strategies at Western Asset, one of Franklin Templeton’s specialist investment managers.
Bellows, who prior to joining Franklin Templeton in 2012 served as acting assistant secretary for economic policy at the US Treasury, said the “risks around the Fed” in the second half of the year will be more balanced than in the first half. “I think there’s a risk for a dovish adjustment at some point,“ he said on Wednesday in the firm’s international webinar. Economists say that “doves” are less troubled by inflation, whereas “hawks” have a low tolerance for it.
He explained his view of “more moderate inflation going forward”, by pointing to moderating wage demands and a cooling off in the housing sector.
Growth is slowing to trend
Estimates for the rate of growth varied among the panellists. Franklin Templeton Investment Solution’s head of research Gene Podkaminer emphasised that while growth is slowing, “it’s slowing to trend at this point,” he said. “So not to zero, not to negative, but something like trend that we’ve experienced over the last couple of decades.”
Bellows disputed this assessment, stating that “I think the risks are that we slow and slow below trend”. He pointed out to growth “risks to the downside, especially in Europe and especially in China.”
He said most central banks around the world are doing what the US Fed is doing. The European Central Bank “has done a very dramatic pivot,” and is trying to work out what it means for sovereign spreads and peripheral countries. He listed central banks in Canada and Australia as also turning to inflation fighting, but said that risks to growth which are even more pronounced in Europe and potentially in China “limits the enthusiasm of fighting inflation.”
A recession on the way?
Europe is “very clearly” on a path to below trend growth, Bellows said. “I think the discussion in Europe is not whether you’re below trend or not but are you in a recession or not by the end of the year.”
Speaking of recession fears, Podkaminer maintained that the US economy is strong enough to postpone if not prevent a recession. “Looking at unemployment, and generally looking at the labour picture, this does not appear on the surface to be recessionary.”
Podkaminer pointed out that changes in the price of money impact forward-looking earnings from stocks and stock markets around the world. “Growth has a much bigger impact on some of these other asset classes that are not fixed income than we typically see in bonds, unless we’re talking about credit or high yield,” he explained.
Inflation-Protect Securities
Inflation hedges are top of mind these days for investors. Podkaminer mentioned some ways to protect one’s portfolio. He mentioned the US government’s Treasury Inflation-Protect Securities, as well as similar “linkers” or inflation-linked bonds in other countries. He also referred to certain alternative investments, specifically real estate, infrastructure and even commodities. He emphasised that investors should also embedding investments that manage “inflationary whiplash” into their portfolios for the long term, not just when inflation is high.
Francis Gannon, co-chief investment officer at Franklin Templeton’s Royce Investment Partners small cap equities unit, pointed out that while the Standards & Poor’s 500 index officially entered a bear market this week, small caps reached that stage in January, and are down about 30 percent.
Small caps seen as inflation beater
Despite the stock price falls, Gannon pointed out that “what we’re hearing and seeing from companies, from a bottoms-up perspective is that demand remains quite strong.”
“The only major asset class to beat inflation every decade since the 1930s is small caps,” pointed out moderator Jeffrey Schulze of Clearbridge Investments, another Franklin Templeton specialist investment manager.
Bellows spoke about the significant improvement in the yield of investment grade corporate bonds. “We’ve also seen a widening of corporate spreads, which is due to investors being reluctant to hold corporate bonds in a volatile environment.”
Podkaminer expressed his appreciation for the resurgence of fixed income. “Fixed income actually looks appealing and compelling and will probably be even more so as we go through the next couple quarters as yields rise.”
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