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Tue 7 Jan 2014 10:49 AM

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Michael Hasenstab: The global view

Michael Hasenstab, executive vice president and chief investment officer, Global Bonds at Franklin Templeton Investments looks at the risks and rewards of investing in different assets post the Fed’s tapering decision

Michael Hasenstab: The global view
No need to panic Hasenstab says that there is little need to fear that emerging markets will suffer as a result of the Fed’s decision to ease its bond-buying programme.

Global liquidity should continue to increase, in our view, as a number of central banks in developed markets have maintained very loose monetary policies. The Bank of Japan (BOJ) appears likely to accelerate the pace of monetary easing with further measures to amplify accommodative monetary policy in the coming months. The European Central Bank (ECB) recently cut rates a further 25 basis points to 0.25 percent as the Eurozone slowly deleverages and several countries within the Eurozone face ongoing disinflationary pressures. The ECB has indicated it could take further measures.

In the US, the decision by the Federal Reserve (Fed) to begin reducing its bond-purchasing programme in January 2014 was inevitable, in our view, as it is not a realistic expectation for the Fed to print money indefinitely. We believe that the longer the programme continues, the longer distortions in the market could last. Furthermore, we believe it is important to remember that the end of printing new money does not mean the end of loose monetary policy in the US. While the Fed will eventually discontinue new purchases, and eventually even gradually raise interest rates, we believe that would still equate to fairly loose monetary policy at the global level, given the size of the Fed’s outstanding balance sheet, as well as the actions of the BOJ and the ECB. The total pool of global liquidity remains abundant and is likely to continue to expand, in our view.

We believe the fear of liquidity being pulled out of emerging markets due to the Fed eventually ending its bond-purchasing programme is overstated, as we do not believe there would be a massive contraction of liquidity out of emerging markets. Instead, we think the situation will likely result in less new money pouring into these markets. Many emerging markets have a surplus of savings and low indebtedness.

Furthermore, many of these emerging-market countries no longer rely on foreign capital inflows as they did in previous decades due to improved fiscal accounts and a large amount of foreign reserves, which can provide a cushion against capital outflows. When the Fed does end its bond purchases, we believe the interest-rate differential will likely be in favor of emerging markets with high growth and inflation dynamics that should dictate higher interest rates than those in the US. We believe the relative value potential of these countries’ assets is still intact as they have not been printing money; therefore the pace of Fed tapering is unlikely to have a fundamental impact on countries that continue to exhibit strong fundamentals.

The current low levels of interest rates and the likelihood of facing a rising-rate environment are central to our near-term outlook. We expect many emerging markets should benefit from solid fundamentals as well as ongoing capital inflows from worldwide quantitative easing. We remain encouraged about the growth prospects and low indebtedness of many emerging markets. Asia ex-Japan looks reasonably strong to us, as do select economies in Latin America and Europe. We believe credit conditions have remained favourable here given their low levels of debt and relatively stronger growth rates.

What are the risks?

All investments involve risks, including possible loss of principal. Generally, those offering the potential for higher returns are accompanied by a higher degree of risk. Stock prices fluctuate, sometimes rapidly and dramatically, due to factors affecting individual companies, particular industries or sectors, or general market conditions. Special risks are associated with foreign investing, including currency fluctuations, economic instability and political developments.

Investments in emerging markets, of which frontier markets are a subset, involve heightened risks related to the same factors, in addition to those associated with their relatively small size, lesser liquidity and lack of established legal, political, business and social frameworks to support securities markets. Because these frameworks are typically even less developed in frontier markets, as well as various factors including the increased potential for extreme price volatility, illiquidity, trade barriers and exchange controls, the risks associated with emerging markets are magnified in frontier markets.

The financial instability of some countries in the EU, together with the risk of that impacting other more stable countries, may increase the volatility and risk of investing in companies in Europe. Value securities may not increase in price as anticipated or may decline further in value. Smaller-company stocks have historically had more price volatility than large-company stocks, particularly over the short term.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.

Changes in the financial strength of a bond issuer or in a bond’s credit rating may affect its value. Lower-rated bonds and distressed debt entail higher credit risk. Mergers, reorganisations, liquidations and other special events involve special risks as pending deals may not be completed on time or on favorable terms. Short sales of securities involve the risk that losses may exceed the original amount invested. Investing in the natural resources sector involves special risks, including increased susceptibility to adverse economic and regulatory developments affecting the sector—the prices of such securities can be volatile, particularly over the short term.

Real estate securities involve special risks, such as declines in the value of real estate and increased susceptibility to adverse economic or regulatory developments affecting the sector. Diversification does not guarantee a profit or protect against a loss. These and other risks pertaining to specific funds or strategies, such as those involving investments in specialised industry sectors or use of complex securities, are discussed in the relevant fund’s prospectus.

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