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Chris Molumphy: Frank Talk on Fundamentals

November 1, 2011

A listless economy, volatile markets and the continuing European debt crisis have many investors worried that the U.S.is on the precipice of the long-feared double dip recession. Could it happen? Possibly. But before getting caught up in extreme scenarios, investors should consider that the market could be eradicating economic excesses that may help pave the way for reacceleration and growth. Chris Molumphy, CIO of Franklin Templeton Fixed Income Group®, notes how current conditions exhibit some distinct differences from those of 2007-2008, and where he sees opportunity in the bond market:

“There’s no question that it’s been an exceptionally volatile period marked by a flight to quality. Risk aversion has also been a key theme and many assets—including credit—have traded off, in many cases indiscriminately, regardless of fundamentals. That said, the fundamentals simply have not changed that dramatically over the past several months and, overall, are reasonably positive.”

Although European leaders finally reached an agreement to reduce Greece’s debts, shore up the region’s banks and reinforce its bailout fund to prevent the crisis from spreading and to protect its currency from unraveling, their plans’ effectiveness will depend on executing the details, which may take several weeks or months. This scenario may continue to affect short- and longer-term yields in the U.S.Although European markets may present some good opportunities because of the dislocation occurring there, the primary challenge facing investors seeking income is the overall low-yield environment:

“It’s probably not an environment to be greedy when it comes to yield or income.  Our view is that over the longer term, given the fundamentals, yields most likely have to go a fair amount higher.  That said, whenever the market experiences a good deal of volatility, it may also present opportunities.”

Although the U.S. Treasuries downgrade certainly contributed to market volatility, Molumphy considers them one of the better-performing asset classes over the past several months. He also cites corporate credit as an example where he believes fundamentals do not justify some of the cheaper valuations of late:

“We think current valuations relative to fundamentals present opportunities in the corporate market and looking outside the U.S., we see a number of opportunities in the global bond market.”  

Addressing the likelihood of a double dip, Molumphy cites the marked differences between current economic conditions and those of 2007-2008. Despite sluggish and uneven growth and subdued consumer spending, macroeconomic data shows none of the excesses typically associated with the onset of a recession:

“While recession is certainly a possibility, we think it’s fairly unlikely in the near term. Housing prices are 30-35 percent lower than they were before the bubble burst in 2007. Consumers are in much better shape, averaging 5 percent savings. Corporations have deleveraged and have cash on their balance sheets. Financial institutions don’t have the bad assets that we saw in 2007-2008. This is a different environment from the one we saw leading up to the last recession.”

Until next time, Beyond Bulls & Bears leaves you with this quote from Sir John Templeton:

“Investors are the people who buy for fundamental values. Speculators are those who buy in the hope of selling later to someone else at high prices.”

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