As we ring in a new year, it’s a good time to gain some perspective on where we’ve been, and where we might be headed. In the first few weeks of January, Beyond Bulls & Bears will be featuring a series of investment commentaries from select Franklin Templeton investment management teams. These professionals provide their insights on the market ups and downs of 2012, and the potential challenges and opportunities that may lie ahead from their respective vantage points. Today we hear from Michael Hasenstab, portfolio manager and co-director of the International Bond Department. Read more…
When faced with a seemingly insurmountable challenge, it’s tempting to stick one’s head in the sand like an ostrich, and hope it goes away. Some have said that about U.S. politicians when it comes to the nation’s $1 trillion deficit. The ominous-sounding combination of automatic spending cuts and tax hikes dubbed the “fiscal cliff,” a precipitous plan deadlocked politicians put in place last year, has the U.S. on edge. How do we feel standing at the edge of a cliff? Is there an urge to back away? To jump? To build a safe passage across the abyss? Set to go into effect on January 1, 2013, it remains to be seen what—if anything—Congress will do to change or delay these measures, and what longer-term solutions to tackle the deficit will be put forth.
Dr. Michael Hasenstab, co-director of Franklin Templeton Fixed Income Group’s® International Bond Department, doesn’t prescribe legislative answers, but he can relate the fiscal challenges the U.S. faces to the experiences of a country with its own dramatic cliffs: Ireland.
The whims of investor sentiment often hold sway over the markets, even if fundamentals might seem to dictate otherwise. A “herd” mentality can take over and certain asset classes or regions fall out of favor, whether rightly or wrongly so. In the first half of this year, the investing herd was stampeding out of Europe, with its crushing debt crisis and specter of a euro breakup. Today it appears sentiment is shifting direction—toward the euro’s survival—so will the herd make a U-turn? John Beck, London-based SVP and co-director of Franklin Templeton’s International Bond Group, is cautiously optimistic, but he’s also a realist about the time it will take for Europe to recover.
Investors have grown impatient waiting for the eurozone economies to recover, but Beck reminds us that patience is a virtue. He says it is impossible to go around the time required for the recovery process, but he is already seeing improvement in three key areas: the banking system, sovereign debt, and politics. Read more…
There’s a certain Hollywood mystique around the image of the rogue investor with the fortitude to diverge from the crowd on the quest for The Next Great Investment. The un-glamorous truth, of course, is that unearthing hidden opportunities actually takes equal parts elbow grease and know-how. Par Rostom, portfolio manager and vice president of Franklin Equity Group®, is that
roll-up-the-sleeves kind of guy. He’s not looking to invest in companies just because they are household names with splashy advertising campaigns. The companies he hunts for are the ones he feels are “best in class” in their particular niche, but that you’ve probably never heard of. Surprisingly, he’s finding some of them in the eurozone, a place the crowd is largely avoiding today. Here’s a summary of his approach, in his words:
- We’re looking for companies that grow sustainably in terms of free cash flow over time.
- We look at the returns profile for a company historically, and we project that out three to five years.
- We also make sure that we would view the corporate governance as best in class.
- A concentrated portfolio allows our analysts to focus…it allows us to take advantage of transient dislocations.
Who doesn’t love a bargain? Scoring something sought-after at a discount can be as thrilling for shoppers on Main Street as deal-hunters on Wall Street. Ferreting out finds takes time, though, and not everyone has the patience—or the resources—to do that legwork. But Katrina Dudley, portfolio manager with Mutual Series® , is a savvy stock shopper with ample amounts of both. Read on for a taste of her stock-picking approach as inspired by the Mutual Series’ guiding principle: “buy a dollar’s worth of assets at a discount.”
- Macro considerations are important, but they don’t change our stock-by-stock selection process
- Volatility is here to stay, but it can create opportunity
- We’re looking at the company-level impact of macro influences like eurozone austerity
- Many European companies are readjusting their cost base, becoming more competitive Read more…
Many investors were leery about diving into the market last year, and who can blame them given global debt debacles, job and housing concerns, and a shaky growth outlook. While the market still faces these crosscurrents, the S&P 500’s best January performance in more than a decade 1 and the recent reprieve in a key measure of market volatility are providing hints that gun-shy investors might be dipping a toe back in.
Easier said than done for some. After the rollercoaster that was 2011, trying to explain why now seems like a good time to venture back in still sounds a little crazy. But for those who are looking for some perspective, you’ve come to the right place. Read on for why Ed Jamieson, president/CIO of Franklin Equity Group®, Peter Langerman, president/CEO of Mutual Series®, Gary Motyl, president/CIO of Templeton Global Equity Group, and Mark Mobius, executive chairman of Templeton Emerging Markets Group, all think it might be time for investors to consider taking the plunge. In brief:
Gary Motyl: “We do expect the global GDP environment to remain challenging—looking for slower global GDP growth but still growth.”
Ed Jamieson: “The market appears more relaxed about world events than one might imagine.”
Peter Langerman: “If you look at one of the commonly referenced measures of volatility, the Chicago Board Options Exchange Market Volatility Index, or the VIX, we are actually at a level which isn’t that far above where we were all the way back in 2007.”
Mark Mobius: “I don’t believe China’s economy is going to experience a hard landing. I expect the China plane will keep on flying.” Read more…
Jerry Palmieri, Vice President and Sr. Portfolio Manager for Franklin Equity Group, doesn’t worry too much about whether the Greek drama dominating daily headlines will turn into global market tragedy. A veteran of Franklin Templeton since 1965, he’s survived to tell the tale after more than four decades of market ups and downs. His wizened view summarized:
- Market ups and downs are to be expected.
- U.S. market, economy will survive the Greek debt crisis. ”Things will work out.”
- Market timing not the ticket to long-term investing success.
Ups and Downs Are To Be Expected
On “Black Monday,” October 19, 1987, the Dow Jones Industrial Average plunged more than 508 points, or roughly 22%.1 Following the market plunge, Palmieri, a longtime fund manager, earned the respect of his peers for his calm demeanor and diligence during a time few market veterans could ever forget. During one of the worst crashes in the history of the market, Palmieri maintained his resolve that despite the crash, the equity market was still the place for investors to be over the long-term.
Some market-watchers believe that markets have been dominated by fear, inspiring investors to panic and liquidate investments that are otherwise fundamentally sound. They throw out the baby with the bathwater, so to speak. Dr. Michael Hasenstab, SVP and Co-Director, International Bond Department for Franklin Templeton Fixed Income Group, doesn’t scare so easily, though. As he reiterated recently, he actually sees times of market panic as opportunities to make investments where he sees long-term value. The key thoughts he shared:
- The challenge during periods of volatility is that, although investors can take a short-term hit, this volatility can create opportunity.
- Fears Europe will sink Asia appear “overblown.”China is not likely to see a “hard landing.”
- The eurozone drama continues to unfold.
- Chris Molumphy: “The labor markets certainly aren’t in great condition, but the trends seem, in our view, to be positive.”
- Roger Bayston: “We do not expect any meaningful policy changes regarding the future of Fannie and Freddie until after the U.S. Presidential election this fall.”
- Michael Hasenstab: “It is absolutely essential that a number of these European policy measures that were started are followed through on.”
- Eric Takaha: “We have been viewing the financial market gyrations over the past year as longer-term investment opportunities.”
- Rafael Costas: “By now everybody knows that 2011 was, in the minds of many, a surprisingly strong year for municipal bonds, but it was, however, a pretty uneven year.”
The idea behind fixed income is to have a predictable amount of money coming in at predictable intervals. Against a market backdrop that’s only predictable in its unpredicatability, the promise of a steady income probably sounds pretty alluring to a lot of investors right now. So, as we emerge from a very volatile 2011 and wade into what may well be a similarly volatile 2012, how’s the fixed income space sitting? Great question! We’re glad you asked.
Chris Molumphy, CIO – Franklin Templeton Fixed Income Group®: U.S. Fixed Income Overview
The labor markets certainly aren’t in great condition, but the trends seem, in our view, to be positive.
Partially driven by the improved jobs picture, the consumer, generally speaking, appears to be reasonably healthy. The corporate sector continues to be a source of strength for the overall economy. And, of late, we are finally seeing signs of some hiring in the corporate sector. Our outlook for inflation is that it is likely to generally remain benign in 2012.
Now, having said that, we’re not without challenges. Real estate certainly remains stubbornly problematic and likely will remain a headwind in the overall U.S. economy. In our view, though, valuations—broadly speaking—are near their lows. Despite the downgrade mid-year, we still have not really made much progress on the federal debt level in the United States. We ended fiscal 2011 with a significant deficit of roughly $1.3 trillion, or approximately 9% of GDP. And, finally, we continue to work our way through the sovereign debt crisis in Europe. While volatility could certainly persist as we look through the first half of 2012, we’re cautiously optimistic that we will see some resolution this year.
In sum, our view is that the fundamental backdrop is reasonably constructive as we enter 2012 and, as the market inevitably trades on these fundamentals, that should bode well for a number of different fixed income sectors in the coming year.
Roger Bayston, Senior VP – Franklin Templeton Fixed Income Group®: Fannie and Freddie
It’s been over three years since Fannie Mae and Freddie Mac were put into government conservatorship. With their future in doubt—and it should be noted that both organizations have current mandates to shrink their portfolios—the U.S. Federal Reserve has been there to pick up the pieces and try to keep the market-driven mortgage rates low. This was one clear intention of the quantitative easing policy now known as QE-2, announced in the fall of 2010.
Should the Fed announce further QE measures, we would expect they would continue to focus on attempting to keep mortgage rates low to support U.S. residential real estate. Continuing to buy agency mortgage pass-throughs will likely be one of their tools. In addition, we expect them to continue to help owners deleverage their household balance sheets through refinancing at the very low rates available. This requires working with banks and mortgage servicers to clear current hurdles that are preventing large amounts of refinancing from happening.
We do not expect any meaningful policy changes regarding the future of Fannie and Freddie until after the U.S. Presidential election this fall. Given the huge debt loads each organization carries, politicians are leery of supporting decisions that might add to the very difficult U.S. fiscal debt position.
Dr. Michael Hasenstab, Co-Director – International Bond Department: Impact of Eurozone Woes
One of the key challenges in 2012 will be, I think, implementation: it is absolutely essential that a number of these policy measures that were started are followed through on. There are six key issues with implementation that we need to watch and I expect that, within the next three to six months, we will get clarity on a lot of them.
1) European fiscal union. I think this is the cornerstone of putting Europe on a more sustainable path, and we need to continue to see that followed through.
2) Budget follow through in Italy. Italy has passed some very austere and difficult budget measures. We need to see follow through there and make sure there isn’t backsliding, and we need to see some follow-through on the labor market reforms.
3) Greek restructuring. We have always maintained a view that Greek’s debt was insolvent and it was a matter of time. I think that time is quickly approaching and, hopefully, we can have a restructuring and move beyond that. I think it would be healthy to no longer have that in the headlines, but it could create some short-term volatility.
4) Will we see ongoing QE out of Europe? Will they continue to commit their balance sheet to the Central Bank in periods of stress? So far they’ve indicated a willingness to do this, and I think this will be important to monitor.
5) Emerging market monetary policy. We’ve seen some easing in monetary policy in emerging markets. This has helped cushion those economies against a global slowdown. One of the strengths that emerging markets have is the ability to actually lower interest rates. But we need to make sure they don’t get behind the curve and ease too much, given that demand conditions are actually pretty reasonable in those markets.
6) U.S. debt dynamics. In this political year, U.S. debt discussions seem to be completely at an impasse, and that will be important.
Eric Takaha, Director – Corporate and High-Yield Credit Group: Corporate, Leveraged and High-Yield Debt
If you just focused on the headlines dominating the news in 2011 you could have reasonably assumed that 2011 would’ve been a fairly difficult year for corporate credit. However, when you look at valuations, while they did cheapen, overall returns were actually positive.
In particular, U.S. corporations posted positive year-over-year earnings growth throughout 2011, even during the more difficult U.S. economic environment experienced earlier in the year. Valuations across the corporate credit markets in 2011 were driven more by the negative headline news stories than by the generally supportive credit fundamentals. Consequently, while total returns were positive, yield spread valuations did cheapen, particularly in the latter half of the year.
Looking at the leveraged loan sector in the investment-grade corporate markets, we see similar trends of cheapening valuations over the course of 2011, diverging from the credit fundamentals that were being reported by many issuers. Similar to the high-yield sector, the leveraged floating-rate bank loan market has also benefited from supportive fundamental credit trends.
Rafael Costas, Co-Director – Municipal Bond Department: Municipal Bond Market Overview
By now everybody knows that 2011 was, in the minds of many, a surprisingly strong year for municipal bonds, but it was, however, a pretty uneven year. If you’ll remember, the first part of the year was filled with negative headlines and underperformance following the tough end of 2010. However, by the end of the 2011, as people started to realize that the worst-case scenario—calling for hundreds of billions of dollars in defaults—was nowhere close to being what actually would happen, demand started coming up. Demand was also fueled by persistent fears about the global equity markets, particularly Europe, that sent more money coming back into the “perceived” safer investments of Treasuries and municipal bonds. We do want to make sure, however, that we temper expectations for 2012. It was a great year, but to expect double-digit returns in municipal bonds is not realistic, it doesn’t match up with history.
I would caution everybody to be mindful of the really good numbers that some of our leveraged competitors may be posting. The leverage process amplifies returns in the upside, but it also amplifies them on the downside, and so before people get too enticed by double-digit returns, I remind them to look at the performance of any instrument on the down years—and you have plenty of examples recently—so you can see what the downside potential of those instruments is and decide whether you or your client can handle that kind of downside risk before you invest.
As soon as we hang our 2012 calendars we are, like clockwork, inundated with a plethora of economic prognostications. Eager forecasters make predictions ranging from 5,000 point market rallies to, literally, the end of the world. Forecasting, however, is a dicey pursuit. As 2011 proved, any number of unforeseen market-rocking variables can occur.
In keeping with our heritage, Beyond Bulls & Bears is taking a contrarian approach to forecasting, steering clear of sensationalism and relying instead on the opinions of three of our industry veterans who place emphasis on rolled-up sleeves research and long-term outcomes. Each shares his insights on three key factors that have been affecting global markets as 2011 drew to a close and as the new year swings into action.