Preoccupation with the ‘now’ undermines returns for investors: Franklin Templeton

While turmoil in US politics and ongoing conflicts in Europe and the Middle East have prompted many investors to take decisive – perhaps impulsive – actions regarding their portfolios, they are far better off riding out the current storms and pursuing a medium- to long-term strategy for their returns, argues Stephen Dover, head of the Franklin Templeton Institute.

“When it comes to increasing prosperity, the longer term is key,” Dover said in a just-released report. Investment horizons report. “Many studies have shown that strategic asset allocation decisions and adherence to them determine the lion’s share of a portfolio’s return and risk over time.”

Dover predicts a mix of “continuity and change” in capital markets in the coming years, led by a gradual decline in policy rates towards neutral.

He sees continued high relative returns for dominant companies in growth sectors. The underperformance of value stocks is likely to continue, “given the absence of a catalyst in the form of increased profitability.”

“Our analysis suggests that slower corporate earnings growth will likely lead to more modest equity market performance in the coming years, particularly in the United States, where already high valuations are likely to limit room for multiple expansion as interest rates fall.”

Corporate earnings are likely to decline in the coming years to growth rates of about 5% to 6% per year, slightly lower than the postwar average of 7.4%.

According to Dover, the US is “likely to continue to offer attractive equity returns relative to other major markets, thanks to better relative growth, innovation and profitability.”

Changes in capital markets are likely to be driven by a slowdown in global growth and falling inflation, allowing central banks to cut policy rates.

Fixed-income funds with a duration are likely to benefit the most from falling interest rates, as investors can currently lock in attractive rates.

“The government bond markets, particularly in the United States, offer what we believe to be an attractive prospect for investors willing to extend the duration of their fixed income investments,” Dover said.

With short-term interest rates expected to fall by around 2-3 percentage points in the US, UK and eurozone, Dover predicts the return outlook in global government bond markets “will be attractive over the coming years”.

However, the credit market poses a challenge for investors.

“The yields for potential credit risk and downgrades… are generally too low, reducing the attractiveness of broad corporate bond indices.

“Within credit… valuations are less attractive,” Dover wrote. “Both investment-grade and high-yield markets have historically exhibited tight spreads over government bonds. Too tight, in our view, to account for the heightened risk of downgrades and defaults that are likely to emerge as growth continues to slow.”

Dover concludes: “In a world of modest earnings growth, investors are likely to continue to pay for earnings visibility and growth. Secular themes, both existing and emerging, will offer what we believe are attractive returns for medium-term focused investors.

“We believe that AI, robotics, genetics, electricity investments and digital finance are the most attractive themes for the coming years.”