Franklin Templeton: Preparing the post-pandemic playbook
KUALA LUMPUR: In looking at investments post-pandemic, Franklin Templeton Investment Solutions believe risks to recovery are still tilted to the downside, but continues to look toward 2021 with cautious optimism, following an extraordinary period for global financial markets.
Its chief investment officer Edward Perks expect both monetary and fiscal stimulus measures to continue deep into 2021, but without much clarity about the pace of the global economic recovery.
He said the speed at which governments can overcome the Covid-19 pandemic, alongside the efficacy of vaccines, will dictate how stimulus is implemented and when the pivot away from current levels of support will come.
“Commitment from central banks and governments is still unquestioned at this point, but the outlook is not as transparent as we would like it to be,” he said in his analysis yesterday.
“The concept of “lower for longer” interest rates is wellestablished and should remain in place throughout 2021, although the approach major central banks will take toward broader quantitative easing is more difficult to predict.
“For example, there is an argument to suggest that the unprecedented support for “fallen angels” – companies previously rated as investment grade that have been downgraded to high yield – will cease as the recovery gathers pace.
“This was a powerful and unusual measure taken to prevent the dislocation of the global economy and cannot be guaranteed to remain in place. Insufficient stimulus could potentially increase volatility within markets as corporate defaults multiply and asset prices begin to lose value on falling demand and deteriorating market sentiment.”
Despite the best efforts of policymakers, Perks believe inflation expectations will remain subdued across developed markets throughout 2021 and are unlikely to increase much until 2022 at the earliest, as economic weakness and high unemployment continue to balance the effect of stimulus.
“There is, however, a scenario in which central banks and governments remain cautious in the face of a surprisingly sharp economic recovery, maintaining stimulus beyond the point that economic indicators would deem necessary, scarred by the damage incurred in 2020.
“These circumstances, taken together with rising consumer demand, may mean inflation begins to increase sooner than forecast, particularly in the US.
“This would have a profound impact on fixed income markets, as yields on long-term US Treasury bonds are currently very low, and the robust performance of long-duration assets was a feature of the early part of 2020 due to a flattening yield curve.”
This is unlikely to unwind completely in 2021, Perks added, but the US Treasury yield curve has already begun to steepen.
Essentially, excessive stimulus, combined with the release of pent-up demand in a postpandemic environment, has the potential to raise inflation and would prove a challenge for investors with a longer-term perspective predicated on a steady recovery.
“Real assets such as commodities, alongside Treasury Inflation-Protected Securities (TIPS), are favorable correlation diversifiers, in our assessment, and can help us to counteract the effects of any unexpected increase in inflation,” he continued.
“Lower-volatility investments such as developed market government bonds, gold or highquality stocks also form part of our portfolios should volatility increase.”
Meanwhile, the election of Joe Biden as US president seems to have calmed financial markets, as investors enjoy some muchneeded clarity.
“The outlook for fiscal stimulus is still unclear though, and any near-term support agreed by the US Congress is likely to be smaller in scope than desired by the Democrats.
“Aside from the delivery of emergency economic support, the incoming US administration also has a mandate to change the current approach in many policy areas, including international relations, infrastructure, taxation and climate change, although a potential lack of control over the US Senate makes it harder to implement the full wish list.
“Failing to extend existing measures designed to support the economy risks killing a nascent recovery and would, in our view, be a policy misstep. Implementation of new policies should wait until the economy is demonstrably post-pandemic.”