The great reopening story has dominated financial market discussions for many months and is expected to lead to increasingly synchronised global growth in the second half of this year, says Edward Perks (pictured), chief investment officer, Franklin Templeton Investment Solutions.
This growth, along with inflation concerns, supports a stronger, medium-term return potential for stocks rather than bonds. Although policymakers may adjust the parameters of their stimulus programs, their objectives will not change. We continue to expect a supportive policy environment.
Within this environment, riskier assets continue to look attractive while lower-risk bonds more on the expensive side. However, with such uncertainties facing global economies still, the traditional benefits of a balanced portfolio between stocks and bonds continue to be the most likely path toward stable potential returns.
Policy is likely to be adjusted, but its objective will not change
Much of the market debate today is focused on the interplay of policy stimulus, economic growth and the path of inflation. The need to promote a transition to a green economy may drive the move toward a larger government sector, with countries trying to lessen inequalities and bounce back better after the pandemic.
It has also seen a shift in the balance of power between fiscal and monetary policy. A rise in government expenditure and transfer payments is providing more of the ongoing stim¬ulus for the global economy, implicitly reflecting the reality of limited scope to cut official interest rates from central banks.
However, as policymakers see the recovery become better established, they will adjust the parameters of their stimulus programs. It would risk a policy error on the part of at least some central banks if they did not do so, but they are still likely to retain an accommodative monetary policy stance overall.
On balance, we remain opti¬mistic that ample stimulus will continue to be provided to the global economy as necessary.
Bonds provide income diversification; Equities have brighter total return prospects
While the macro backdrop therefore continues to look supportive, navigating the challenges presented in the months ahead will require nimble portfolio management. One of the key considerations for those with multi-asset portfolios is the extent to which focus is on preferred assets, such as stocks, in the current climate.
When facing this challenge balance is key, as maintaining a diversified portfolio of risk premia is the most likely path towards stable potential returns. This is particularly the case in the future low-return environment, where diversified portfolios alongside active management styles can enhance potential returns and manage the level of total portfolio risk taken.
These basic elements of the multi-asset approach necessitate the search for alternatives, traditionally incorporating government and corporate bonds to provide a measure of diversification. However, after more than three decades of a broad bull market for bonds, it is hardly surprising that many investors express the view that government bonds are expensive, with current nominal yields remain close to historical lows.
However, as faster growth and fears of resurgent inflation continue to rise, global bonds (especially high credit quality and long-duration issues) are important for portfolios due to their apparent reduced vulnerability to low term premia which counterbalances these concerns.
Despite the anticipated return from high-quality bonds remaining modest in comparison to stocks, their residual portfolio risk-reducing characteristics means they should be included in longer-term portfolios.
Notably, concerns about depressed government bond yields do extend to the higher-quality parts of the corporate bond market, as if government bond yields rise sharply prices of most high-quality bonds will drop.
So, the attractions of corporate bonds most likely lie in offering a modest additional yield and some potential diversification benefits from government bonds, rather than as a long-term return generating alternative to stocks.
More recently, many companies have grown confident enough to initiate, restore or raise their dividends as pandemic-related uncertainty subsides and demand normalizes across most sectors. This shift should be welcomed by multi-asset investors, as the improving economic background can support earnings growth among a multitude of sectors.
Many businesses show an ability to support today's dividends yields and grow them over time. With global equity valuations at reasonable levels, a combination of modest earnings growth and sustainable dividends lead to more attractive long-term total return prospects for equities than bonds.
Cash still has a role to play in portfolios
Overall, while bonds have a role to play in a portfolio for diversification purposes, we continue to find few compelling alternatives to equities when it comes to generating an appealing longer-term return. Bonds of various flavours might enhance portfolio-level risk-adjusted return to an extent but are not suffi¬ciently compelling to drive us toward a higher conviction allocation at this time.
In the near term, the defensive features of cash holdings look more appealing, despite their drag on portfolio yield. Short-dated US Treasury yields, as well as cash instruments globally in the developed world, reflect depressed policy rates and continued high levels of liquidity. Cash does, however, have attractions as a means of diversification from low-yielding government bonds and complements the attraction of higher-risk assets such as equities.
By Edward Perks, chief investment officer, Franklin Templeton Investment Solutions
