by Stephen H. Dover, CFA, Chief Market Strategist, Head of Franklin Templeton Institute
Stocks, bonds, currencies and commodities have made significant moves in the past few months. Find out what factors to consider when deploying or redeploying capital from Franklin Templeton Instituteâs Stephen Dover.
Spring has arrived. Itâs time to clear out closets and cupboards, store winter things, give away or toss out items no longer needed and generally make the house sparkle.
Whatâs good for the home is good for the portfolio. Spring is a great time to revisit investments, discard whatâs no longer needed or wanted and refresh oneâs portfolio with the best investment ideas for the months ahead.
A lot has happened in the last few months, underscored by significant moves in stocks, bonds, currencies and commodities. Those factors must now be considered when deploying or redeploying capital.
Whatâs changed?
The most significant market shift since the beginning of the year has been a dramatic and unanticipated rise in global bond yields. From their early January levels of 3.86%, US 10-year Treasury yields have climbed some 80 basis points to their current rate near 4.70%.
Rising Treasury yields have caused equity markets to wobble, with the S&P 500 Index down 3% from its late-March peak.1 Rising US yields have also propelled the US dollar higher in the worldâs foreign exchange markets. Year-to-date, the dollar is up 12% versus the Japanese yen and 4% in trade-weighted terms.2 Meanwhile, crude oil prices have advanced 16% in the first four months of the year.3
Several factors have accounted for these dramatic market shifts. But what we see as most important is the combination of resilient US growth (defying expectations of a recession) and sticky US inflation (which was supposed to keep falling but has not). As a result, the Federal Reserve (Fed) has indicated that any rate cuts will come later and more gradually than had been anticipated earlier this year. The re-pricing of Fed easing has been the most important driver of rising yields, which in turn has supported the US dollar and eroded demand for equities.
Surging oil prices also reflect better-than-expected US (and global) growth as well as heightened uncertainty about Mideast crude oil supplies. Attacks on shipping headed for the Suez Canal have forced many deliveries to take the longer route around southern Africa, adding to crude oilâs cost and supply concerns.
How our views have changed
The question then is: Have these changes in macroeconomic, geopolitical and market terms changed our views about how to invest?
In some ways, yes, though in others, they have reinforced our prior convictions.
Take bond yields and duration. We see higher bond yields as an opportunity, rather than a risk. The ongoing restraint applied by restrictive Fed policy should slow US growth and inflation. While the lags between Fed rate hikes and weaker demand have lengthened in recent years (owing to the higher fraction of household and business borrowings at longer, fixed-rate maturities), the effectiveness of monetary policy has not been blunted. As more consumers and business re-finance or borrow for the first time, they will confront some of the highest borrowing costs seen in two decades.
Equally, inflation has only temporarily stopped falling. Seasonally, many firms raise prices early in the year, which is one reason why inflation has leveled off at rates above where the Fed can ease. Lags are also at work, for example, in insurance premiums to reflect the higher costs of autos and homes. But over time, those price pressures are likely to dissipate.
In contrast, shelter costs (derived from house prices and rents) have become more resistant to Fed tightening. Thatâs because demand for housing remains strong, underpinned by solid jobs growth. Meanwhile, housing supply has been slow to respond to demand, in large part because homeowners with low-rate mortgages are reluctant to sell.
But even sticky shelter inflation wonât likely be enough to prevent some further softening of US overall inflation later this year. Together with weakening of growth, we think the stage will be set for US bond yields to decline over the remainder of 2024.
Portfolio implications
Accordingly, we believe longer-duration US Treasuries and high-quality corporate credits ought to deliver attractive returns through year-end. Meanwhile, credit spreads remain tight. As a result, risk-reward does not favor lower quality credits, such as high yield.
Recent wobbles notwithstanding, we remain committed to global equities. US corporate profits have resumed growing, after falling for much of 2023, and should benefit from the resilience of the economy, alongside solid profit margins.
Nevertheless, some eventual slowing of US growth argues against rotation to cyclicals, smaller capitalization, or value styles. We prefer higher-quality stocks, able to deliver earnings through the cycle while offering sustainable dividends. We continue to believe that shares of disruptive technologies and companies with dominant business models will also perform well.
It is tempting to see value in non-US markets. However, it is also important to note that growth, earnings and inflation dynamics in Europe, Japan and many parts of the emerging complex are headwinds. Europe, for example, remains mired in economic stagnation. Emerging markets are unlikely to rebound in advance of a broader global recovery.
Lastly, commodity prices, and in particular crude oil prices, remain a wild card, owing to the potential for conflict to interrupt supply. Seasonally, demand for gasoline and other distillates is rising. But during the second half of 2024, some deceleration of US and global growth should result in a pullback of oil and other cyclical commodity prices.
Conclusions
Periodically, portfolios require re-assessment. We believe spring is an opportune time, given significant moves in bond yields and currencies thus far in 2024.
The start of 2024 has caught many investors off guard. Resilient US growth and inflation have defied expectations, leading to higher bond yields and a surging US dollar. Equities have paused following their strong advance since October 2023.
Those unexpected outcomes offer reason to re-evaluate portfolio positioning. In some cases, weâre inclined to change views, for example regarding US dollar strength, which is likely to persist. But in many ways our fundamental assessment about what will drive stock and bond returns remains intact. We see even more compelling value in duration fixed income. Earnings should support equities, albeit with leadership in defensive rather than cyclical sectors.
*****
WHAT ARE THE RISKS?
All investments involve risks, including possible loss of principal.
Equity securities are subject to price fluctuation and possible loss of principal.
Fixed income securities involve interest rate, credit, inflation and reinvestment risks, and possible loss of principal. As interest rates rise, the value of fixed income securities falls. Changes in the credit rating of a bond, or in the credit rating or financial strength of a bondâs issuer, insurer or guarantor, may affect the bondâs value. Low-rated, high-yield bonds are subject to greater price volatility, illiquidity and possibility of default.
Commodity-related investments are subject to additional risks such as commodity index volatility, investor speculation, interest rates, weather, tax and regulatory developments.
International investments are subject to special risks, including currency fluctuations and social, economic and political uncertainties, which could increase volatility.
IMPORTANT LEGAL INFORMATION
This material is intended to be of general interest only and should not be construed as individual investment advice or a recommendation or solicitation to buy, sell or hold any security or to adopt any investment strategy. It does not constitute legal or tax advice. This material may not be reproduced, distributed or published without prior written permission from Franklin Templeton.
The views expressed are those of the investment manager and the comments, opinions and analyses are rendered as at publication date and may change without notice. The underlying assumptions and these views are subject to change based on market and other conditions and may differ from other portfolio managers or of the firm as a whole. The information provided in this material is not intended as a complete analysis of every material fact regarding any country, region or market. There is no assurance that any prediction, projection or forecast on the economy, stock market, bond market or the economic trends of the markets will be realized. The value of investments and the income from them can go down as well as up and you may not get back the full amount that you invested. Past performance is not necessarily indicative nor a guarantee of future performance. All investments involve risks, including possible loss of principal.
Any research and analysis contained in this material has been procured by Franklin Templeton for its own purposes and may be acted upon in that connection and, as such, is provided to you incidentally. Data from third party sources may have been used in the preparation of this material and Franklin Templeton (âFTâ) has not independently verified, validated or audited such data. Although information has been obtained from sources that Franklin Templeton believes to be reliable, no guarantee can be given as to its accuracy and such information may be incomplete or condensed and may be subject to change at any time without notice. The mention of any individual securities should neither constitute nor be construed as a recommendation to purchase, hold or sell any securities, and the information provided regarding such individual securities (if any) is not a sufficient basis upon which to make an investment decision. FT accepts no liability whatsoever for any loss arising from use of this information and reliance upon the comments, opinions and analyses in the material is at the sole discretion of the user.
Products, services and information may not be available in all jurisdictions and are offered outside the U.S. by other FT affiliates and/or their distributors as local laws and regulation permits. Please consult your own financial professional or Franklin Templeton institutional contact for further information on availability of products and services in your jurisdiction.
Issued in the U.S.: Franklin Resources, Inc. and its subsidiaries offer investment management services through multiple investment advisers registered with the SEC. Franklin Distributors, LLC and Putnam Retail Management LP, members FINRA/SIPC, are Franklin Templeton broker/dealers, which provide registered representative services. Franklin Templeton, One Franklin Parkway, San Mateo, California 94403-1906, (800) DIAL BEN/342-5236, franklintempleton.com.
CFAÂŽ and Chartered Financial AnalystÂŽ are trademarks owned by CFA Institute.
____________
1. Source: CNBC. Indexes are unmanaged and one cannot directly invest in them. They do not include fees, expenses or sales charges. Past performance is not an indicator or a guarantee of future results.
2. Source: St. Louis Federal Reserve. YTD through April 29, 2024.
3. Source: CNBC. Based on YTD ICE Brent crude prices.
