While short-term market gyrations can be painful for investors’ portfolios at times, Michael Hasenstab of Templeton Global Macro is patiently plotting his strategy for longer-term market shifts. He says recent investor panic has created some once-in-a-multi-decade opportunities for fixed income investors, particularly in some beleaguered emerging markets.
Executive Vice President, Portfolio Manager
Chief Investment Officer
Templeton Global Macro
Two Distinct Market Periods in 2015
Market activity in 2015 can be divided into two distinct parts: what occurred in the first part of the year up through the end of June; and what we have seen since the end of June to the present. In the first part of the year, market activity was very much aligned with what we have been positioned for in our global bond strategies, with the euro and yen continuing to weaken and US Treasuries underperforming. Those events provided opportunities to hold and accumulate positions in select emerging markets that had experienced currency depreciations of anywhere from 10%–15%.
At the end of June, markets then entered a period of panic and massive risk aversion triggered by economic concerns in China. Many emerging market currencies depreciated another 10%–15%, while the yen and the euro remained largely flat, acting as perceived safe havens. Concurrently, US Treasuries appreciated. The combination of these events was a perfect storm against our global bond strategies. But what encourages us is that many emerging market currencies are now in many cases 15%–30% undervalued, in our assessment, and we were able to use this period of volatility to continue to find or build on opportunities in we saw in distressed assets. We saw specific valuations reach levels that are not only a once-in-a-decade opportunity, but what we believe to be rare multi-decade opportunities to capture extraordinary longer-term investment potential.
Positioning for Rising US Interest Rates
We don’t think that this recent period of complete panic is likely to continue. We think the greater risk is the sensitivity of financial markets to a rise in interest rates. Thus, in our strategies we want to be positioned for interest rates to go higher (specifically US Treasuries) and have a negative correlation1 to the bond market as well as other risk assets that could be affected by higher interest rates.
We think the big tragedy in a lot of investors’ portfolios will be the belief that the correlations of the last 30 years will hold—namely inverse correlations of equities and bonds. But when they don’t—when we potentially get a falling bond market and a falling equity market—people’s portfolios may not be well positioned. We haven’t seen that scenario for the last 30 years, but that doesn’t mean it can’t happen. We are now in extraordinary times; we’ve never had monetary policy distort Treasury markets to the current extent, so we have to think a little bit differently. What worked for the last 30 years might not work for the next five years. Therefore, we have to be pro-active and create a portfolio that has these different characteristics and that has the potential to be uncorrelated to rising interest rates.
Three Areas of Investment Opportunity Ahead
In regard to our strategy, we are currently focused on three main areas of investment potential: 1) the profound value opportunities in specific emerging markets, 2) short US Treasuries in a rising-rate environment and 3) the flexibility of management within the currency markets to be long and short. These three broad sources of investment return really excite us about the opportunity set for the next couple years.
First, right now we are focused on select emerging markets at multi-decade and/or all-time low valuations. These include the Mexican peso, which is at the weakest level it has been in the history of Mexico. Similarly, the Malaysian ringgit and the Indonesian rupiah are at levels we have not seen since the Asian financial crisis in 1998. On a valuation basis, these are not just once-in-a-decade, but multi-decade opportunities to buy what we believe to be very cheap assets. Certainly, not all emerging markets have good value. We are not buying everything. We’re not investing in countries such as Turkey or South Africa, for example. But, there are a handful of countries that are being caught up in the current market turmoil that we think are the diamonds in the rough—multi-decade opportunities, or for some of these countries, once-in-their-history—opportunities.
Second, we are positioning our portfolios to aim at a negative correlation to US Treasuries. We view one of the biggest risks over the next five years to be rising US interest rates. In our assessment, the strength of the US economy justifies higher rates and we think inflation is underpriced in the Treasury yield curve. For the last 30 years, most investors money from declining rates; we think over the next five years you want to make money from rising rates. Thus, our strategy is positioned to be short US Treasury duration.
Third, we believe it’s important to have a highly flexible strategy that can directionally position across the currency markets. One of the most attractive aspects of the currency markets is there is generally always something undervalued; things are usually never in perfect alignment. Thus, an investor can allocate in opposing directions; for example, going long the US dollar or short the US dollar. Currently, we have the flexibility to be long the US dollar against short positioning of the yen, the euro, and the Australian dollar. At the same time, we can also short the US dollar against long positions in currencies that we view as undervalued, such as the Mexican peso. Those strategies could completely flip around in a couple of years if we see valuations adjust, so the flexibility to move to where value resides in the currency markets is an opportunity set that we believe never runs out. By contrast, other security markets often depend on where they are in an investment cycle. Taken together, we see vast opportunity sets for the upcoming years.
So in conclusion, it is our view that currently, there are attractive value opportunities in many emerging markets. Second, being short US Treasuries in a rising-rate environment. And, third, the flexibility within currency markets to be long/short. Those are the three areas that really excite us about the opportunity set over the next couple of years.
For a more detailed analysis of markets around the world, read “Global Macro Shifts,” a research-based briefing on global economies featuring the analysis and views of Dr. Michael Hasenstab and senior members of Templeton Global Macro.
Dr. Hasenstab and his team manage Templeton’s global bond strategies, including unconstrained fixed income, currency and global macro. This economic team, trained in some of the leading universities in the world, integrates global macroeconomic analysis with in-depth country research to help identify long-term imbalances that translate to investment opportunities.
The comments, opinions and analyses are the personal views expressed by the investment manager and are intended to be for informational purposes and 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 information provided in this material is rendered as at publication date and may change without notice, and it is not intended as a complete analysis of every material fact regarding any country, region market or investment.
Data from third-party sources may have been used in the preparation of this material and Franklin Templeton Investments (“FTI”) has not independently verified, validated or audited such data. FTI 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 by FTI affiliates and/or their distributors as local laws and regulations permit. Please consult your own professional adviser for further information on availability of products and services in your jurisdiction.
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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 the prices of bonds in an investment portfolio adjust to a rise in interest rates, the value of the portfolio may decline. Special risks are associated with foreign investing, including currency fluctuations, economic instability and political developments. Investments in developing markets, of which frontier markets are a subset, involve heightened risks related to the same factors, in addition to those associated with these markets’ smaller size, lesser liquidity and lack of established legal, political, business and social frameworks to support securities markets.
1. Correlation measures the degree to which two investments move in tandem. Correlation will range between 1 (perfect positive correlation, where two items historically have moved in the same direction) and -1 (perfect negative correlation, where two items historically have moved in opposite directions).