Investors need more guidance than ever

At the company’s annual global investment outlook in December, Green reminded guests that a year can be a long time in the markets. That is an understatement in the year of COVID. What lies ahead for Canadian investors? At the virtual event, two Franklin Templeton experts reviewed their expectations for 2021 and beyond.

Bill Yun, executive vice president, Franklin Templeton Investment Solutions in New York, said the global equity risk premium is at an attractive level of about 4.5%. Global equity valuations remain desirable relative to bonds. And the low-interest-rate environment is supportive of risk assets.

Yun reviewed projections for the capital market landscape over the next seven years. He sees Canadian equities at 5.5% (vs. a historical return of 6.1%), U.S. equities at 5.4% (vs. 5.9%), international equities at 5.3% (vs. 3.3%), emerging market equities at 7% (vs. 6.7%) and Government of Canada bonds at 1.1% (vs. 5.6%). These return expectations are slightly lower than Franklin Templeton’s 2020 outlook, which came out before the global economy was rocked by the coronavirus pandemic. The defensive positioning of portfolios at the start of 2020 allowed Franklin Templeton to use volatility to its advantage through dynamic portfolio management.

Moving into the next economic cycle, Yun said long-term investment themes include accommodative fiscal and momentary policies. He noted stimulus spending of approximately US$10 trillion globally and counting.

The policies will ensure liquidity will be abundant, added Ian Riach, senior vice president and portfolio manager at Franklin Templeton Investment Solutions in Toronto. “There’s a risk if liquidity gets pulled from the economy prematurely, but we think central banks and governments will manage it,” he said.

Will corporations continue to borrow? Yes, said Yun. Rising debt could leave them vulnerable if interest rates increase. However, those rates remain at historic lows.

Yun expects moderate global growth, likely returning to trend post-COVID. He charted how eight key asset classes have performed each year over the last decade, with global bonds the leading performer year to date as of October 2020. The asset classes were all over the map, and no one stayed at the top or bottom for long. This bolsters the case for active investing, he said. Franklin Templeton’s 2021 capital market expectations are for emerging market equities to lead other asset classes with an expected return of 7% over the next seven years.

Riach followed up with a Canadian economic and market perspective. He’s hopeful about equities in the next 12–18 months, although the recovery and growth may be choppy. “We see short-term headwinds from second-wave virus effects,” he said.

Specifically, Riach envisions cyclical and structural challenges in the energy sector. He said debt loads will hinder future economic growth in Canada. “We continue to underweight Canada and overweight U.S. exposure.”

Overall, Riach is more optimistic about U.S. and emerging markets than Canada. There are simply more opportunities for diversification, growth and risk management abroad. The concentration in the Canadian market isn’t news but remains an impediment.

Riach sees a role for bonds, which tend to dampen volatility in portfolios, but believes they need to be actively managed. “Keep it dynamic and be selective,” he said. That will be key to generating excess income.

In a Q&A after their presentations, Riach said inflation will likely stay muted, keeping interest rates lower. He said central banks have said they will let inflation run hot for a bit to let the recovery gain traction. “In the near term, inflation isn’t a concern,” he said.

Riach and Yun also weighed in on investing with environmental, social and governance (ESG) criteria. They are major considerations in how portfolios are constructed, said Yun. Franklin Templeton signed the U.N. Principles of Responsible of Investment and created a specialized ESG group to work with their investment teams. That’s from a top-down standpoint. From the bottom up, Yun said all teams have embedded ESG in their selection processes. They combine ESG criteria with their traditional fundamental analysis to find appropriate securities.

Riach said ESG criteria relate to long-term viability. “Portfolio managers are making investment decisions with indefinite holding periods. If businesses don’t take ESG into account, they won’t be sustainable,” he said.

The event concluded with a keynote from Stephen Poloz, former governor of the Bank of Canada and currently a special advisor at Osler, Hoskin & Harcourt LLP. Poloz described what he calls the five “tectonic forces” acting on the Canadian economy:

1. An aging population. Demographics hinder the potential growth rate of the economy. Within the next few years, too, immigration will create all the growth in the labour force.
2. Rising indebtedness at levels not seen since the aftermath of the Second World War.
3. Technological progress. We’ve experienced three leaps big enough to be labelled as industrial revolutions – the steam engine, electrification and computer chip deployment. In each, “companies needed to adapt or be forced out of business,” Poloz said. Now, the fourth industrial revolution involves digitization and artificial intelligence (AI). The same old fears are increasing that large firms will reap the benefits and ordinary workers will be left behind.
4. Rising inequality. People expect economic growth to be like yeast – spread everywhere, said Poloz. In reality, growth is more like mushrooms – popping up here and there. That creates discontent.
5. Climate change. While a green economy will create jobs, the transition will push new costs onto much of the economy and result in some job losses, too.

Like the shifting tectonic plates of the Earth’s crust, these, too, are forces of nature and can cause quakes, Poloz said. The multiplicity of interactions creates unpredictable financial outcomes.

Beyond the implications for investors, the five forces can trigger social disruption. Consider, for instance, how rising indebtedness and inequality can drive political populism – what Poloz calls a “toxic confluence.” The COVID-19 pandemic might accelerate all these trends.

But Poloz doesn’t foresee a drawn-out recession. Household disposable income is up, and spending fell only because the economy shut down. News on the vaccine front is positive. But the macro situation is really a tale of two economies, said Poloz.

Poloz predicts the post-COVID economy will resemble the letter K. For most of the economy, we’ll see a classic V-shaped recovery, as in the top of the K. However, the bottom part of the K represents areas that will struggle, like retail, oil production, travel, hospitality and the restaurant sector. There will be winners and losers, said Poloz, and some impacts might become permanent. “If the bottom part of the K stays weak, so will the total,” he said.

To learn more about Franklin Templeton solutions and insights, visit www.franklintempleton.ca.