CONTRIBUTORS
Max Gokhman, CFA
Deputy Chief Investment Officer
Franklin Templeton Investment Solutions
Tom Nelson, CFA, CAIA
Head of Market Strategy
Franklin Templeton Investment Solutions
Miles Sampson, CFA
Head of Asset Allocation Research,
Franklin Templeton Investment Solutions
Preview
In this month’s Allocation Views, we adopt a positive view of risk assets ahead of the final quarter of 2025, as we weigh extended equity valuations against a generally positive macro environment, strong corporate fundamentals and monetary policy easing.
The strength of the current global equity rally has surprised many market participants, given stocks have brushed off tariff uncertainty, inflation concerns and labor market weakness to post stellar gains.
Such a powerful advance naturally brings warnings about irrational exuberance, especially where retail investors are concerned. However, we prefer to take a more measured approach, examining the underlying macro and corporate environment for signs of weakness.
Our analysis finds a broadly positive setup for risk assets, where improving business activity and solid economic growth has provided the platform for a strong second-quarter earnings season. Policy easing amid steady growth has further bolstered equity market momentum.
From a cross-asset perspective, we balance this stance by strengthening our pessimism toward fixed income.
Macro themes driving our views
A resilient growth story
- Leading economic indicators remain resilient, driven by strong services growth.
- Forward-looking surveys have reversed recent pessimism, and earnings revisions have improved.
- Greater clarity around US trade policy has supported sentiment, but we are monitoring labor market dynamics for further signs of weakness.
Balanced inflation outlook
- Inflation remains above central bank targets in most developed economies. We expect inflation to remain sticky through the end of this year, influenced by tariffs.
- US companies are currently absorbing tariff-induced inflation pressures by tightening margins. An additional material impact on core goods inflation is likely.
- However, services inflation has moderated, helped by lower housing costs, and should offset pressures elsewhere.
Policy leans supportive
- We expect the Federal Reserve (Fed) to adopt a more dovish interest-rate strategy, but we think expectations are lofty relative to a balanced inflation outlook.
- Despite the impact of perceived political influence, we believe the Federal Open Market Committee’s (FOMC) will maintain an objective approach to monetary policy.
- Fiscal policy in major economies such as the United States and Germany has become an influential driver of asset prices, notably the US tax bill.
Portfolio positioning themes
Responsibly bullish
- Several major central banks are currently easing into strengthening economies, offering a tailwind to risk assets.
- Positive earnings revisions and guidance reflect robust corporate fundamentals, supporting equity market momentum.
- Despite the recent rally in equities, sentiment appears surprisingly neutral. Positioning also remains restrained, leaving room to add risk.
Diversified equity risk
- We retain our optimistic view of US large-cap stocks relative to small-cap names. Robust earnings and renewed enthusiasm for artificial intelligence (AI) guide our thinking.
- We upgrade Chinese equities, as a technology rally and positive AI trends fuel markets. Sustained retail activity is also a factor.
- We retain an optimistic view on Canadian equities, helped by an improved commodities outlook. Elsewhere we retain pessimism toward Japanese stocks.
Underweight government bonds
- We believe market expectations for Fed policy easing are somewhat optimistic. This maintains upward pressure on longer-term yields, curtailing our preference for US duration.
- Concerns around fiscal sustainability have driven higher term premia in US Treasuries (USTs), increasing the possibility of a supply-demand imbalance.
- Within fixed income, we prefer UK Gilts and Canadian government bonds amid weak labor markets.
WHAT ARE THE RISKS?
All investments involve risks, including possible loss of principal.
Equity securities are subject to price fluctuation and possible loss of principal.
Fixed income securities involve interest rate, credit, inflation and reinvestment risks, and possible loss of principal. As interest rates rise, the value of fixed income securities falls. Changes in the credit rating of a bond, or in the credit rating or financial strength of a bond’s issuer, insurer or guarantor, may affect the bond’s value. Low-rated, high-yield bonds are subject to greater price volatility, illiquidity and possibility of default.
The allocation of assets among different strategies, asset classes and investments may not prove beneficial or produce the desired results. To the extent a strategy invests in companies in a specific country or region, it may experience greater volatility than a strategy that is more broadly diversified geographically.
Commodity-related investments are subject to additional risks such as commodity index volatility, investor speculation, interest rates, weather, tax and regulatory developments.
International investments are subject to special risks, including currency fluctuations and social, economic and political uncertainties, which could increase volatility. These risks are magnified in emerging markets. The government’s participation in the economy is still high and, therefore, investments in China will be subject to larger regulatory risk levels compared to many other countries.
Investing in privately held companies presents certain challenges and involves incremental risks as opposed to investments in public companies, such as dealing with the lack of available information about these companies as well as their general lack of liquidity.
Active management does not ensure gains or protect against market declines. Diversification does not guarantee a profit or protect against a loss.
WF: 7028308