TIME TO RESET EXPECTATIONS?...US interest rates go up 100 or 200 basis points, there is still a huge differential. There are some higher-yielding, domestically oriented countries that

TIME TO RESET EXPECTATIONS?GLOBAL INVESTMENT OUTLOOKSEPTEMBER 2017

Unwinding Quantitative Easing—Will It Unwind the Markets?

Market Stability or Volatility—How Should Investors Prepare?

The Elephant in the Investment Room

Key Takeaways for Investors

Not FDIC Insured May Lose Value No Bank Guarantee

FEATURED SENIOR INVESTMENT LEADERS

The information provided is not a complete analysis of every material fact regarding any country, region, or market. Comments,

opinions and analyses contained herein are those of the speaker and are for informational purposes only. Because market and

economic conditions are subject to change, comments, opinions and analyses are rendered as of August 29, 2017, and may change

without notice. The analysis and opinions expressed herein may differ or be contrary to those expressed by other business areas,

portfolio managers or investment management teams at Franklin Templeton Investments. Opinions are intended to provide insight on

macroeconomic issues and commentary is not intended as individual investment advice or a recommendation or solicitation to buy, sell

or hold any security or to adopt any investment strategy.

All investments involve risks, including possible loss of principal. Foreign securities involve special risks, including currency

fluctuations and economic and political uncertainties. Investments in emerging markets involve heightened risks related to the same

factors, in addition to those associated with these markets’ smaller size and lesser liquidity. Bond prices generally move in the opposite

direction of interest rates. As the prices of bonds in an investment portfolio adjust to a rise in interest rates, the value of the portfolio

may decline. Stock prices fluctuate, sometimes rapidly and dramatically, due to factors affecting individual companies, particular

industries or sectors, or general market conditions. Diversification does not assure or guarantee better performance and cannot

eliminate the risk of investment losses.

This document summarizes the video content from our panel discussion.

To watch the videos online visit: www.franklintempleton.com/investor/insights/investment-outlook-2017

Global markets have been relatively calm this summer despite many

uncertainties. Geopolitical risks have continued across the globe,

and in some areas, looming monetary policy changes also appear

likely. A key question for many investors is whether the sleepy

summer period of low volatility will give way to a more turbulent

autumn. Franklin Templeton’s senior investment leaders offer their

perspective on the markets, and discuss where they see

opportunities and risks ahead.

Christopher J. Molumphy, CFA

Chief Investment Officer

Franklin Templeton Fixed Income Group®

Stephen H. Dover, CFA

Head of Equities

Edward D. Perks, CFA


Franklin Templeton Multi-Asset Solutions

Michael Hasenstab, Ph.D.


Templeton Global Macro

Contents

Unwinding Quantitative Easing—Will It Unwind the Markets? 1

Market Stability or Volatility—How Should Investors Prepare? 5

The Elephant in the Investment Room 6

Key Takeaways for Investors 7

http://www.franklintempleton.com/investor/insights/investment-outlook-2017

FRANKLIN TEMPLETON INVESTMENTS | 1

Q:MICHAEL HASENSTAB:

There has been a lot of focus on the speed

and extent of interest-rate hikes out of the

US Federal Reserve (Fed), but I think there

hasn’t been enough focus on what

happens when the central bank starts to

unwind its balance sheet. I think the United

States will be the first central bank to

unwind, with Europe following suit at some

point. Japan isn’t really in a position yet to

be unwinding though, in my view. Even if

the Bank of Japan stops quantitative

easing (QE), I believe it will still target the

10-year yield to keep it close to zero.

There is a concern that the Fed has never

unwound such a large amount of assets

before, and the likelihood that there are no

disruptions is theoretically possible, but

seems pretty unlikely in practice. We just

have to be ready for that. And, it’s not just

what the Fed is doing in terms of its

balance sheet that is important. We have a

lot of deregulation happening and there

could be fiscal spending coming as well.

It’s a pretty complicated US landscape.

CHRISTOPHER MOLUMPHY: To Michael’s point, central bankers have

Unwinding Quantitative Easing—Will It Unwind

the Markets?

2017 GLOBAL INVESTMENT OUTLOOK | TIME TO RESET EXPECTATIONS?

Central banks have remained a focus of global markets. Can you give us

an update on what different central banks around the world are

telegraphing?

quite a task ahead of them. The Fed

started with a balance sheet of less than $1

trillion, and now it’s up to $4.5 trillion, so it

has some work to do to unwind it. I think

the Fed has done a reasonably good job

recently of trying to telegraph its intentions.

In our view, we could see some action as

early as the September policy meeting. So

far, the market seems receptive—it seems

to be pricing it in. But as Michael noted, it’s

a big action in front of us and there are a lot

of things that could go wrong.

When Central Bankers Purge Their Balance Sheets…What Then?Total Assets of Major Central Banks

September 30, 2006–July 31, 2017

Source: Bloomberg. Most recent data available.

$0

$2

$4

$6

$8

$10

$12

$14

$16

9/06 2/08 6/09 10/10 2/12 7/13 11/14 3/16 7/17

USD Trillion

US Federal Reserve Bank of Japan European Central Bank

$5.0 Trillion

$4.6 Trillion

$4.5 Trillion

2 | FRANKLIN TEMPLETON INVESTMENTS


Q:CHRISTOPHER MOLUMPHY:

The Fed’s primary holdings are US

Treasuries and mortgages. So far, those

markets have held up reasonably well, but

the Fed has also telegraphed a very slow

start to the normalization process. In our

view, the Fed should move forward while

the market is reasonably receptive

because market conditions can change,

and there are a lot of variables out there.

ED PERKS: I think another thing that’s relevant is the

possible transition we could see at the Fed.

Fed Chair Janet Yellen’s term is scheduled

to end early in 2018, so I think the markets

will increasingly be focused on the Fed’s

potential path under new leadership if it

seems likely she won’t continue on.

CHRISTOPHER MOLUMPHY: While Yellen isn’t totally out of the running

for a second term, at this point, it seems

likely that there could be a new Fed chair.

When we think about monetary policy

going forward, the impact of that transition

is a question mark. As Ed pointed out, we

are in the later innings of Yellen’s term, so

we will need to see some transition

communications sooner rather than later.

MICHAEL HASENSTAB:

In my view, it might be a good thing to have

someone from the market side at the Fed’s

So what might you expect to happen when the Fed does normalize, in

terms of a potential market reaction?

helm. I think one of the challenges for the

Fed is policymakers have been in a bit of

an ivory tower and the world has changed.

So I think it could be encouraging if we saw

someone with a markets background.

But back to US monetary policy and the

implications, I think it’s pretty simple. I

believe interest rates need to go higher.

The United States now has full

employment, economic growth is at or

above potential and the output gap has

closed. Inflation has not come into the

picture yet, but it’s probably just a matter of

time as it’s a lagging indicator. All of these

factors point to a 10-year US Treasury yield

that should be higher than 2%.

US Economy Appears to Be Strong with Full Employment… US Unemployment Rate

June 30, 2010–June 30, 2017

Source: Bloomberg, National Bureau of Economic Research. Most recent data available.

…And Near Potential Growth

US Output Gap

January 1, 2007–April 1, 2017

Source: US Congressional Budget Office, US Bureau of Economic Analysis. Most recent

data available

0%

2%

4%

6%

8%

10%

12%

6/10 6/11 6/12 6/13 6/14 6/15 6/16 6/17

Unemployment Rate

$13,000

$13,500

$14,000

$14,500

$15,000

$15,500

$16,000

$16,500

$17,000

$17,500

1/07 6/08 12/09 5/11 11/12 4/14 10/15 3/17

USD Billion

Real Potential GDP Real GDP

4/17


CHRISTOPHER MOLUMPHY:

We have a more intermediate-to-longer-

term investment horizon, so we try to stay

long-term focused. We have a reasonably

constructive view on the economy globally

and on the United States in particular. With

that, we are trying to take advantage of

some of the shorter-term volatility where it

creates potential buying opportunities. The

US economy has been growing at about

2% annually, which isn’t a great rate of

growth, but it’s decent from the perspective

of a fixed income investor. The United

States has been growing at that pace for

the entirety of this current cycle’s growth

phase, which is now into its ninth year. At

least over the near term, we see a

reasonably constructive corporate

environment, and the consumer appears to

be in decent shape, too. Our focus has

probably close to peaking given the issues

Europe continues to face with the refugee

crisis and terrorism.

The situation will probably be a little

different against emerging markets

because many of those countries have a

huge yield advantage over the United

States. For example, long-end rates in

Brazil are running about 10%, so even if

US interest rates go up 100 or 200 basis

points, there is still a huge differential.

There are some higher-yielding,

domestically oriented countries that I think

will see their currencies do well if we see

the type of constructive economic backdrop

Chris just spoke of. Some countries which

have very low bond yields might be more

vulnerable to a US rate hike. So I think we

will see greater bifurcation in emerging-

market currencies.

When US Interest Rates Start to Normalize, Select Emerging-Market Currencies May Hold Up Better than the Euro and Yen 10-Year Government Bond Yields

As of August 31, 2017

Source: Bloomberg.

been on asset classes such as corporate

credit. We are still reasonably constructive

on corporates, as well as mortgage-backed

securities, but are staying diversified

because we do not see a lot of cheap

sectors in the fixed income markets right

now. That said, we’re willing to take some

reasonable level of risk because we think

the fundamentals will remain fairly strong in

the near-to-intermediate term.

MICHAEL HASENSTAB:If the Fed moves first and interest rates in

the United States start to normalize, then

higher US rates combined with stable rates

in Japan or Europe should lead to a

stronger US dollar, at least temporarily.

And we think there are a lot of headwinds

for the euro and yen beyond just interest

rates. We believe euro strength is

How should investors think about opportunities that are being created or

potentially disappearing?Q:

2.29%

0.54%0.08%

9.99%

0%

2%

4%

6%

8%

10%

12%

United States Germany Japan Brazil




STEPHEN DOVER:

Corporate earnings have not only been

strong but also coordinated around the

world, which is the first time that’s

happened in quite a while. Earnings

continue to surprise on the upside,

especially in emerging markets, and to

some degree in Europe now, too. I think as

long as interest rates rise on a measured

basis, that’s probably priced into the

market at this point. The environment is

relatively benign, and markets are

relatively calm, so the risk is that if there’s

a shock, I think the markets probably are

not really prepared.

Ultimately, as long as companies have

earnings growth, the market should be able

to keep moving higher. In general, we have

seen opportunities in Europe, which has

had some economic turnaround and some

positive political developments. European

banks are doing better than many had

thought they would. Financials in general

still haven’t completely recovered from the

2007–2009 global financial crisis, providing

additional upside potential. So we still see

opportunities in that space, to some

degree. However, there are some big tail

risks in Europe that probably are not priced

into the market at this point. We also see a

lot of opportunity in emerging markets

where there is growth and positive political

change—or at least select emerging

markets such as in Latin America.

Corporate Earnings Have Improved Across Most MarketsEarnings per Share

July 31, 2007–July 31, 2017

Source: FactSet, MSCI. Data presented is 12-month forward earnings per share indexed to 100 at 7/31/07.

0

20

40

60

80

100

120

140

160

7/07 7/08 7/09 7/10 7/11 7/12 7/13 7/14 7/15 7/16 7/17

United States Europe Japan Emerging Markets

Ultimately, as long as

companies have

earnings growth, the

market should be able

to keep moving

higher.

– Stephen Dover

“

”



Q:ED PERKS:

I think it’s important to step back beyond

just the last 12–15 months. If you take a

longer perspective, just two years ago the

markets saw substantially higher volatility.

Broader global equity indexes experienced

a sharp correction from the middle of 2015

to the early part of 2016. That said, I think

this current period of low volatility has

come with a lot of benefits. In the years

since the global financial crisis, the

purpose of the Fed’s monetary actions, and

of global central-bank actions in general,

was to bring down volatility in asset classes

and more broadly in the economy and we

certainly received some benefits from that.

We have seen the US and global economy

continue to grow at a relatively modest

pace. I think the low market volatility we

have seen likely had some influence on the

relatively strong business and consumer

confidence that exists today. For investors,

it has enabled more of a focus on

fundamentals, which have been strong.

However, this period of relatively low—I

wouldn’t say unprecedented, but I would

say relatively low—volatility is unlikely to

persist. From my perspective, the

unknowns would be the more significant

risks that might lie out there. During the last

several years, we have seen a tremendous

amount of assets move into passive

strategies. So, to what extent will we see

algorithmic, indiscriminate selling of

Market Stability or Volatility—How Should

Investors Prepare?

In spite of different risk factors, equity-market volatility remains near

historic lows. How should investors think about risk in equity markets

right now?

equities, of assets in general as volatility

moves higher? That’s something that we

are a bit concerned about and something I

think investors need to think about.

STEPHEN DOVER: To Ed’s point, passive funds are in

essence momentum players—buying

“high” on appreciating stocks that get

progressively larger weightings in an index

while selling “low” on those that depreciate

and get progressively smaller in the index,

regardless of the stocks’ future upside

potential. The possibility of indiscriminate

selling is one of the things we are looking

Market Volatility Has Been Low, But When Will the Tide Turn?CBOE Volatility Index (VIX) and Realized Volatility of S&P 500 Index

December 31, 2015–July 31, 2017

Source: FactSet, Chicago Board of Exchange, S&P. Standard deviation is a measure of the degree to which a portfolio’s

return varies from the average of its previous returns. The larger the standard deviation, the greater the likelihood (and

risk) that a portfolio’s performance will fluctuate from the average return. The Chicago Board Options Exchange (CBOE)

Volatility Index, or VIX, measures the market’s expectation of 30-day volatility. It is constructed using implied volatilities of

S&P 500 index options. Indexes are unmanaged and one cannot directly invest in an index. They do not include fees,

expenses or sales charges. Past performance does not guarantee future results.

at from a research point of view. We are

looking at how much a company is owned

by indexes, or by passive investors,

because that money could move out very

quickly and affect the company.

Low-volatility, coordinated market

environments, and to some extent,

coordinated policies of global central banks

can make it difficult to differentiate which

stocks might outperform. As we experience

the potential for heightened volatility, we

think there will be some likely

differentiation between the active versus

passive space.

0

5

10

15

20

25

30

0%

5%

10%

15%

20%

25%

12/15 3/16 5/16 8/16 10/16 12/16 3/17 5/17 7/17

Three-Month Standard Deviation of S&P 500 Daily Returns (LHS) VIX (RHS)


Q:CHRIS MOLUMPHY:

From our standpoint as fixed income

investors, we think we benefit from our

long-term investment approach in that we

are fundamentally based and look beyond

some of the short-term noise. I think the

markets have done a reasonably good job

looking through some of these non-

fundamental bouts of volatility—political,

geopolitical and otherwise—and have held

up reasonably well. But to your question,

exogenous risks make things a bit more

difficult. At the same time, if you can stick

to your main investment thesis, the

fundamentals and a longer-term horizon,

you can use these events as opportunities.

Bouts of market volatility can create buying

opportunities. What we try to do is

determine whether near-term risks are

going to impact longer-term fundamentals.

More often than not, they tend to be more

transitory in nature.

MICHAEL HASENSTAB:

The shift in many emerging markets to

more orthodox policy has been an area of

opportunity for us. In the United States and

in Europe, there is a much more charged

political environment and, in some cases,

the abandonment of orthodox policy. In

places like Mexico, for example,

policymakers stuck to their guns and hiked

interest rates to protect their currency

(despite speculative attacks), followed

through with fiscal reform and liberalized

the energy sector. We have seen a very

sharp snapback in the peso.

Meanwhile, Brazil has been targeting

corruption in a more forceful manner than

The Elephant in the Investment Room

How are exogenous political risks influencing your investment thesis?

ever there. I think that is going to lead to

some positive political changes. And

Argentina has done a 180 degree, about-

face under President Mauricio Macri to re-

embrace market principles and get the

economy started again. India’s Prime

Minister Narendra Modi has embarked

upon a very rigorous reform of the tax

system and has set in place inflation

targeting with the central bank. So there

have been a lot of positive fundamental

changes in emerging markets that I think

will pay dividends for years to come.

On the flipside, there are places like

Venezuela, which is in a crisis. Bad policies

have led to a financial and humanitarian

crisis there. Currently, Turkey is also facing

challenges. So we are seeing the

bifurcation I mentioned earlier in our

discussion of monetary policy. A lot of that

emerging-market bifurcation is also due to

changes in a political environment—

whether it is improving or deteriorating.

In Europe, we are a little more cautious

medium term. With growth improving, there

is unlikely to be a major flashpoint in the

short term, in my view. However, we are

seeing nationalism grow at levels that it

hasn’t for decades. The desire for Europe

to come together seems to be changing

and there’s more national identity as

opposed to European identity. Longer term,

I think that’s going to be a big challenge for

the eurozone. I think the political

environment in Europe has changed more

in the last couple of years than it has since

1945. For some 60 years, we had one kind

of model moving toward integration, and I

think this may be the first point in time

things are turning in a different direction in

Europe. This isn’t an immediate flashpoint,

but something we see as a potential issue

longer term.

STEPHEN DOVER: I think sometimes, at least in the equity

space, there is so much talk and focus on

politics and macroeconomic events.

Ultimately, though, companies are valuable

based on their discounted earnings stream,

so that’s why we are fundamentally

focused and why we focus on earnings. A

lot of what goes on in politics doesn’t

necessarily affect earnings that much—at

least in the short term. There are things

that do, however, such as the tax plan and

tax reform in the United States, which are

pretty important and could impact earnings.

Overall, I think the political environment

hasn’t had a huge impact on the equity

market because it hasn’t actually affected

earnings streams.

Like Michael, I am pretty enthusiastic about

emerging markets that seem to be more

progressive than the developed markets

are, where politics can make a difference.

There is a lot of room for change in those

markets. In Brazil, as Michael mentioned,

an unpopular government is making

dramatic changes that should have been

done 20 years ago. These changes are

low-hanging fruit in the sense that they are

likely to have a very positive economic

impact and, ultimately, I think, on the

earnings stream for many companies in

Brazil.



ED PERKS:

At the risk of oversimplifying it, I think

diversification is the best rule to follow

when you are thinking about a broader

portfolio. I think the views that we have

shared, relative to equity and fixed income

markets are all relevant. It’s something that

we are specifically looking for in the

exposures we have in multi-asset

portfolios, but ultimately diversification’s

true test is how it performs when we see a

move higher in overall volatility or some

kind of market shock. Do markets see a

rise in correlation across asset classes?

That’s something I think investors have to

be very mindful of. I think there is a range

of strategies investors should consider

focusing on. As investors ourselves,

ultimately, we need to access as broad and

strong a set of building blocks for our

portfolios as possible. Generally, with many

markets at different levels of valuation in

terms of attractiveness, we increasingly

want to be very specific with the exposures

we might be getting in particular asset

classes.

Q: To conclude, what’s your brief takeaway for investors as we look out over

the course of the next year?

CHRIS MOLUMPHY: Within fixed income, there currently are not

many cheap asset classes, particularly on

a historic basis. But there are still areas

within fixed income where we think

fundamentals will remain constructive in

the year ahead. I previously mentioned US

corporate credit as one of those areas,

including investment-grade corporates as

well as high yield and leveraged bank

loans. The fundamentals for municipal

bonds also appear reasonably solid (with

some outliers) and valuations on a relative

basis appear reasonable. In general, I’d

say it’s probably a good time to take a

diversified approach to one’s fixed income

allocation.

ED PERKS:

I believe some of the conditions that have

persisted for a period of time may start to

transition to a different environment. There

are specific exposures we aim for in our

portfolios which are tied to some of the

themes we have touched on. For example,

in this low-volatility environment, using

certain hedging strategies to complement

our strategic asset allocation enables us to

be a bit more nimble. I think the direction of

market volatility is going to be a very

important dynamic over the next six-to-12

months.

STEPHEN DOVER:

I would reiterate the importance of

diversification as well. If you were to look

back 10 years ago, for example, the United

States as a percentage of the global equity

market cap was much smaller than it is

today as the relative strength of the market

over the past decade has led to an

increase in its weight. One has to look at

the trend and what percentage of global

market cap the United States will likely be

in the future, and I think there would be a

strong argument, at a minimum, for some

global diversity and possibly to invest a bit

more outside the United States, as

countries outside the United States have

underperformed over the past few years.

There is so much attention paid to the

political noise. While some political issues

matter, such as tax reform or regulatory

reduction in the United States, which could

impact corporate after-tax earnings, I

wouldn’t get too distracted by it. Finally,

based on empirical feedback, many if not

most investors still seem to be underweight

emerging markets in their portfolios. If you

are underweight, you are essentially saying

they are going to underperform going

forward, which I would evaluate and take

into consideration when looking at your

portfolio.

Key Takeaways for Investors


At the risk of oversimplifying it, I think diversification is the best rule to follow

when you are thinking about a broader portfolio.

– Ed Perks

“ ”



WHAT ARE THE RISKS?

All investments involve risks, including possible loss of principal. Bond prices generally move in the opposite direction of interest rates. Thus,

as the prices of bonds adjust to a rise in interest rates, the share price may decline. Investments in foreign securities involve special risks

including currency fluctuations, economic instability and political developments. Investments in emerging market countries involve heightened

risks related to the same factors, in addition to those associated with these markets’ smaller size, lesser liquidity and lack of established legal,

political, business and social frameworks to support securities markets. Such investments could experience significant price volatility in any

given year. High yields reflect the higher credit risk associated with these lower-rated securities and, in some cases, the lower market prices

for these instruments. Interest rate movements may affect the share price and yield. Stock prices fluctuate, sometimes rapidly and

dramatically, due to factors affecting individual companies, particular industries or sectors, or general market conditions. Treasuries, if held to

maturity, offer a fixed rate of return and fixed principal value; their interest payments and principal are guaranteed.

MICHAEL HASENSTAB: We are trying to do three things in our

strategy. One is to preserve capital when

interest rates go higher, so we achieve that

primarily by going negative duration in the

United States. The second is to generate a

positive return stream. We have attempted

to do that via a rifle-shot approach in

emerging markets. I think there are still

some opportunities to earn a pretty good

carry; yield differentials are very favorable

in select currencies that we think are fairly

valued or undervalued. The third is to limit

the beta to the broader market. We can do

that by focusing on idiosyncratic ideas. For

example, I believe what President Macri

does in Argentina will likely have a greater

impact on the country’s market than global

factors will. We are looking for those

domestic stories, and we can use certain

short strategies to help reduce market beta.

For example, shorting the Aussie dollar to

limit the beta of risk-on/risk-off effects, or

China effects, and isolate the individual

country dynamics. It’s really those three

goals we have in mind: a negative

correlation to rates, idiosyncratic return

ideas in emerging markets, and limit the

market beta.

I think there are still some opportunities to earn a pretty good carry; yield

differentials are very favorable in select currencies that we think are fairly

valued or undervalued.

– Michael Hasenstab

“”


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Distribution outside the U.S. may be made by Templeton Global Advisors

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IMPORTANT LEGAL INFORMATION

This material is intended to be of general interest only and

should not be construed as individual investment advice or a

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or to adopt any investment strategy. It does not constitute

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The views expressed are those of the investment manager

and the comments, opinions and analyses are rendered as of

the publication date and may change without notice. The

information provided in this material is not intended as a

complete analysis of every material fact regarding any country,

region or market. All investments involve risks, including

possible loss of principal.

Data from third party sources may have been used in the

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Germany. Authorised in Germany by IHK Frankfurt M., Reg. no. D-F-

125-TMX1-08. Canada: Issued by Franklin Templeton Investments

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(416) 364-1163, (800) 387-0830, www.franklintempleton.ca. Dubai:

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Copyright © 2017 Franklin Templeton Investments. All rights reserved. UPD3_YECOM_1017

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Documents

TIME TO RESET EXPECTATIONS?...US interest rates go up 100 or 200 basis points, there is still a huge differential. There are some higher-yielding, domestically oriented countries that