INFLATION may feature prominently in many economies, especially the United States, in the days ahead amid the rise in global commodity prices and recovery of the global economy from the Covid-19 fallout.
The question is whether it will just be a short-term cyclical spike into 2022 or a longer-term secular shift.
Such debate, as Franklin Templeton points out, has implications for longer-term interest rates, and hence, investors’ portfolio. In general, market opinion remains divided.
The fund management company, however, is of the opinion that while inflation could occur in the short term, it is not likely to be persistent or rise to levels that would cause stagflation.
Therefore, the group expects the extended low interest-rate environment to continue.
With this backdrop in mind, Franklin Templeton chief market strategist Stephen Dover (pic) says fixed income should remain a vital part of investor portfolios.
This is because fixed-income instruments such as bonds issued by the government and corporates and debt securities can provide portfolios with diversification and ballast.
“Given today’s low interest-rate environment, along with elevated levels of uncertainty – not just around Covid-19, but also regarding US-China trade, Brexit and Middle East tensions – fixed income may play as vital a role as ever in investors’ portfolios, ” Franklin Templeton explains in its recent note to clients.
“Due to its negative correlation to many risk assets, fixed income can provide portfolios with not only diversification, but also ballast, ” it adds.
According to Dover, the group sees opportunities in high-yield and bank-loan instruments, as these potentially offer lower sensitivity to rising interest rates.
While the group does not see great room for capital appreciation, amid tightening spread, in high-yield credit, it does see an attractive yield advantage versus other fixed-income sectors on continued improving fundamentals and valuations. Even so, security selection will remain critical.
“Historically, high-yield credit has done best when inflation is rising from below-average lows, which is likely to be the case this year, ” Franklin Templeton says.
“We continue to position for a ‘reopening trade’ and favour certain cyclical industries, including airlines, cruise lines and select retail segments complemented by a higher-quality bias in those less-cyclical subsectors providing ballast in our portfolios, ” it adds.
As for bank-loan instruments, it points out, current spreads are fairly attractive, given the fact that the sector had underperformed high-yield significantly last year.
It views emerging market debt as attractive, as global economies continue to reopen and recover.
Overall, Franklin Templeton says, emerging markets, led by Asia, have remained relatively resilient, having successfully adapted to or suppressed the virus.
“There’s significant opportunity in emerging markets today, particularly in Asia, but geopolitical risks bear watching, ” Dover says.
He notes given the return to growth in global economies, the group’s strategy is “risk on” in general.
Although stock valuations appear stretched, the group continues to see opportunities in equity investments, particularly in companies on the cutting-edge of change that stand to benefit from the economic expansion and from resilience in emerging markets, especially in Asia.
“With global equities trading near record highs, many investors are questioning the potential for continued gains.
“While reasonable arguments can be made that equity market valuations – particularly in certain sectors – could be defined as overvalued or ‘frothy’ compared to historical levels, generally our managers continue to see opportunities for the equity markets to continue appreciating, ” Franklin Templeton says.
“Our equity managers have an eye on areas of the market that have been transformed by the pandemic, and which can continue to be on the cutting edge of change, ” it adds.
It is optimistic on the potential of a number of software names that support digital transformation; technology enablers of electric vehicles and solar energy; and online dating platforms that have filled the void resulting from a lack of social interaction.
“Over the long term, we believe innovation drives wealth creation in the economy and that investing in innovation offers a high probability of outperforming the market over a full cycle – approximately three to five years, ” Franklin Templeton says.
“Even after the strong performance of the past year, we continue to think we are experiencing a very rich backdrop to invest in innovation as many discrete advancements are becoming economically viable in the economy today, ” it adds.
While recent months have seen a shift towards value-oriented and cyclical names as economies rebound from the Covid-19 slump, Franklin Templeton says it continues to see opportunities across many high-growth companies.
It argues that the discounted cash flow methodology is the best way to determine a company’s intrinsic value, noting standard multiples do not incorporate growth.