Making Sense of Different Signals
Preview
Key Points
- Valuations reset across most assets in 2022, leading to a rise in expectations for long-term returns for many risky assets, including high-yield bonds and equities.
- We view valuations as a better long-term asset allocation signal than a justification for short-term portfolio changes.
- Despite improved long-term return expectations, our cautious near-term macro-outlook—with significant recession risk—leads to a less favorable view of risky assets, such as high-yield bonds and equities, over the next several quarters.
- Putting it all together, the improvement in valuations currently leaves us moderately bearish on risky assets given our cautious cyclical outlook.
Introduction
Franklin Templeton Investment Solutions (FTIS) is optimistic about the performance potential for risky assets over the long term, which we consider to be a full business cycle, or about 10 years. However, our short-term preference (over the next 12 months) for risk assets is more cautious, based on our macro outlook. Some might notice these opposing viewpoints and wonder what signals would make an investment manager bearish in the short-term and bullish over the long-term, and how they balance this tension in a portfolio. Here, we attempt to provide the rationale behind these opposing views. While generally applicable to all risky assets, we will focus specifically on high-yield bonds and equities.
WHAT ARE THE RISKS?
All investments involve risks, including possible loss of principal. The value of investments can go down as well as up, and investors may not get back the full amount invested. Bond prices generally move in the opposite direction of interest rates. Thus, as prices of bonds in an investment portfolio adjust to a rise in interest rates, the value of the portfolio may decline. Investments in lower-rated bonds include higher risk of default and loss of principal. Changes in the credit rating of a bond, or in the credit rating or financial strength of a bond’s issuer, insurer or guarantor, may affect the bond’s value. Floating-rate loans and debt securities tend to be rated below investment grade. Investing in higher-yielding, lower-rated, floating-rate loans and debt securities involves greater risk of default, which could result in loss of principal—a risk that may be heightened in a slowing economy. Interest earned on floating-rate loans varies with changes in prevailing interest rates. Therefore, while floating-rate loans offer higher interest income when interest rates rise, they will also generate less income when interest rates decline. Actively managed strategies could experience losses if the investment manager’s judgment about markets, interest rates or the attractiveness, relative values, liquidity or potential appreciation of particular investments made for a portfolio, proves to be incorrect. There can be no guarantee that an investment manager’s investment techniques or decisions will produce the desired results.
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.
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 information provided in this material is not intended as a complete analysis of every material fact regarding any country, region or market. All investments involve risks, including possible loss of principal.
Data from third party sources may have been used in the preparation of this material and Franklin Templeton ("FT") has not independently verified, validated or audited such data. 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.
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