Beyond Bulls & Bears


Quick Thoughts: Inflation, Debt, and Changing Economic Sweet Spots

Investors need a more flexible, opportunistic approach to investing, given the current low interest rate environment with the likelihood of interest rates rising over the next few years, according to Stephen Dover, Head of Franklin Templeton Investment Institute. He opines on inflation, debt, and changing economic sweet spots.

Over the past 40 years, global interest rate declines created a unique environment that favored capital gains over income. As we examine inflation, interest rates, and the path forward from this low-rate starting point, there is an increasing need to look beyond fixed income at other sources of income.

  • A strong cyclical rebound in global growth, fueled by fiscal expansion and led by the United States and many developed countries, continues as countries manage the COVID-19 pandemic and its virus mutations.
  • Central bank policies remain dovish as countries transition from the aggressive accommodative policy during the pandemic crisis toward supporting a sustained economic recovery.
  • Global supply bottlenecks are the main contributor to current inflation increases and are unlikely to persist. Going forward, globalization, changing demographics, labor dynamics, and technology decrease the likelihood of long-term inflation in the years ahead.
  • Emerging markets are well-positioned to benefit from demographic changes, and global investors seeking increased returns and diversification for their portfolios should consider investing outside of their home countries.
  • We see significant investment growth in alternative assets, including hedge funds and commercial real estate assets, that may provide diversification away from equity and fixed income. Additionally, investing with environmental, social and governance (ESG) awareness will likely continue to lead as one of the fastest-growing investment trends.
  • Rising interest rates do not support fixed income as an appreciating asset class. However, government bonds have historically provided a ballast for portfolios during volatile periods.

Our belief is that investors need a more flexible, opportunistic approach to investing for income, given the current low interest-rate environment and the likelihood of interest rates rising over the next few years. For a more detailed discussion on inflation and interest rates, including insights on when a country reaches its sweet spot of economic development, please watch “Quick Talks: Inflation, Debt, and Changing Economic Sweet Spots.”

What Are the Risks?

All investments involve risks, including the 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 prices of bonds in an investment portfolio adjust to a rise in interest rates, the value of the portfolio may decline. Investments in lower-rated bonds include higher risk of default and loss of principal. Treasuries, if held to maturity, offer a fixed rate of return and fixed principal value; their interest payments and principal are guaranteed.

Hedge funds may make investments in derivatives that involve costs and create economic leverage, which may result in significant volatility and cause losses that significantly exceed the initial investment. Lower-rated or high yield debt securities involve greater credit risk, including the possibility of default or bankruptcy. Currency management strategies could result in losses if currencies do not perform as the investment manager expects. They may make short sales of securities, which involves the risk that losses may exceed the original amount invested.

Merger arbitrage investments risk loss if a proposed reorganization in which the fund invests is renegotiated or terminated. Liquidity risk exists when securities have become more difficult to sell, or are unable to be sold, at the price they have been valued.

Real estate securities involve special risks, such as declines in the value of real estate and increased susceptibility to adverse economic regulatory developments affecting the sector. REITs involve additional risks; since REITs typically are invested in a limited number of projects or in a particular market segment they are more susceptible to adverse developments affecting a single project or market segment than more broadly diversified investments.

Special risks are associated with investing in foreign securities, including risks associated with political and economic developments, trading practices, availability of information, limited markets and currency exchange rate fluctuations and policies; investments in emerging markets involve heightened risks related to the same factors. Investments in alternative investment strategies are complex and speculative investments, entail significant risk and should not be considered a complete investment program. Depending on the product invested in, an investment in alternative investments may provide for only limited liquidity and is suitable only for persons who can afford to lose the entire amount of their investment.

Actively managed strategies could experience losses if the investment manager’s judgment about markets, interest rates or the attractiveness, relative values, liquidity or potential appreciation of particular investments made for a portfolio, proves to be incorrect. There can be no guarantee that an investment manager’s investment techniques or decisions will produce the desired results.

Diversification does not guarantee profit or protect against risk of loss.

Important Legal Information

This material is intended to be of 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. This material may not be reproduced, distributed or published without prior written permission from Franklin Templeton.

The views expressed are those of the investment manager and the comments, opinions and analyses are rendered as at publication date and may change without notice. The underlying assumptions and these views are subject to change based on market and other conditions and may differ from other portfolio managers or of the firm as a whole. The information provided in this material is not intended as a complete analysis of every material fact regarding any country, region or market. There is no assurance that any prediction, projection or forecast on the economy, stock market, bond market or the economic trends of the markets will be realised. The value of investments and the income from them can go down as well as up and you may not get back the full amount that you invested. Past performance is not necessarily indicative nor a guarantee of future performance. All investments involve risks, including possible loss of principal.

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