When you think of Brazil, what immediately springs to mind? Carnivale in Rio? Beautiful people on beautiful beaches? Or maybe colorful investment opportunities? You read that right: investment opportunities. Turns out Brazil is just as interesting to investors as it is to tourists.
Brazil’s economy is grappling with some interesting challenges right now, such as shifts in monetary policy to cope with a possible economic slowdown and preparing to host two major events on the international stage— the 2014 FIFA World Cup Brazil™ and the Olympics in 2016. Marco Freire, Franklin Templeton’s CIO, Brazil Fixed Income for the Local Asset Management team based in Sao Paulo, isn’t sharing any locals-only secrets about either event, but he’s happy to share his insights on how Brazil is approaching these challenges, and to clear up some common misconceptions about Brazil’s markets.
There’s a certain Hollywood mystique around the image of the rogue investor with the fortitude to diverge from the crowd on the quest for The Next Great Investment. The un-glamorous truth, of course, is that unearthing hidden opportunities actually takes equal parts elbow grease and know-how. Par Rostom, portfolio manager and vice president of Franklin Equity Group®, is that
roll-up-the-sleeves kind of guy. He’s not looking to invest in companies just because they are household names with splashy advertising campaigns. The companies he hunts for are the ones he feels are “best in class” in their particular niche, but that you’ve probably never heard of. Surprisingly, he’s finding some of them in the eurozone, a place the crowd is largely avoiding today. Here’s a summary of his approach, in his words:
- We’re looking for companies that grow sustainably in terms of free cash flow over time.
- We look at the returns profile for a company historically, and we project that out three to five years.
- We also make sure that we would view the corporate governance as best in class.
- A concentrated portfolio allows our analysts to focus…it allows us to take advantage of transient dislocations.
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.”
There was once a time—perhaps not too long ago—when fixed income markets were considered to be the unobtrusive, quiet guest at the dinner party. If equity markets were seen as raucous and exciting, fixed income was instead the steady, sure friend who rarely caused any commotion.
My, how things have changed.
Today, much of the investing world’s news is focused on unexpected developments in fixed income. Roger Bayston, Director of Fixed Income for the Franklin Templeton Fixed Income Group®, chatted with us to discuss some recent fixed income themes.
Beyond Bulls & Bears: Roger, the European sovereign debt crisis has really been dominating the news lately. How do you see that impacting U.S. fixed income markets?
Roger Bayston: Concerns over the European debt crisis and related worries regarding a possible restructuring of some financial institutions’ debt holdings— or even some countries’ sovereign debt— raises questions about expected growth in the United States. That feeds into a cycle where risk-based assets are generally avoided, credit spreads increase, and some investors lose their comfort level in investing in riskier assets. In addition, as investors shun what they perceive as risky assets, there has been a flight to assets seen as safer— such as Treasuries. This has kept long-term U.S. government interest rates low, despite the recent credit downgrade.
Beyond Bulls & Bears: Are you seeing any impact as a result of the Fed’s “Operation Twist” on U.S. mortgage rates?
Roger Bayston: “Operation Twist” basically means they’re going to be buying longer-term U.S. government debt in an effort to keep long-term rates low. Essentially, now that the Fed has arrived at a zero interest rate policy on short-term rates, they are continuing just to reassure the market that they will serve as the buyer of last resort, to make sure that monetary policy remains intact, that they are going to be supporting the U.S. financial institutions and the U.S. economy by attempting to keep longer-term interest rates down.
It does help the economy on the margin by keeping other borrowing costs to corporations as well as mortgage financing rates for U.S. households at a lower level.
Beyond Bulls & Bears: Where do you see rates and credit spreads heading next? And where are you finding value?
Roger Bayston: We know the Fed’s already told us that short-term rates are not going to go anywhere anytime soon. I think, by and large, we are going to be in several months of uncertainty related to the resolution of the European sovereign debt crisis and some of the financial institutions in Europe that need to be restructured. During this period of uncertainty, I believe credit spreads in the U.S. are going to remain relatively wide versus the fundamentals and we should see some opportunity due to this dislocation.
Beyond Bulls & Bears: Given current market conditions, what’s your outlook as we head into the end of the year?
Roger Bayston: The market seems to be pricing in a recession in the U.S. and much higher default rates on corporate credits than what the fundamentals suggest. Many corporations in the U.S. are showing resiliency in their balance sheets; they have deleveraged over the past several years, so we are seeing opportunities in certain credit investments.
We expect that we are going to have a bumpy ride in the fourth quarter, but we think that getting the income benefits from those corporate debt securities may be a good opportunity right now.
Additionally, we continue to like some global investments, and we think diversification in global fixed income right now makes a lot of sense.
Beyond Bulls & Bears: It always comes back to diversification. Thanks Roger.
Until next week, Beyond Bulls & Bears leaves you with a quote from Sir John Templeton:
“To avoid having all your eggs in the wrong basket at the wrong time, every investor should diversify.”
IMPORTANT LEGAL INFORMATION
Bond prices generally move in the opposite direction of interest rates. Thus, as the prices of bonds in an investment portfolio adjust to a rise in interest rates, the value of the portfolio may decline. Special risks are associated with foreign investing, including currency fluctuations, economic instability and political developments. Investments in developing markets involve heightened risks related to the same factors, in addition to those associated with their relatively small size and lesser liquidity. The use of derivatives and foreign currency techniques involve special risks as such techniques may not achieve the anticipated benefits and/or may result in losses. Changes in the financial strength of a bond issuer or in a bond’s credit rating may affect its value.
As global markets are roiled by some serious concerns, we at Beyond Bulls & Bears feel it’s a valuable time to take a deep breath and reflect on the sources of potential. After all, the late, great Sir John Templeton believed that for the astute and patient investor, times of maximum pessimism could yield great values. We caught up recently with Research Analyst and Portfolio Manager with Franklin Equity Group, Par Rostom, to discuss the strategies he’s employing to find value.
Beyond Bulls & Bears: You and your team focus on non-US, mid- to large-cap companies with long-term growth potential. What kind of growth potential are you seeing in that segment of the market today?
Par Rostom: We are seeing some pretty good potential in companies earlier in their life-cycle of growth. These companies have focused business models with generally one or two business lines. Our strategy reflects a barbell approach of investing in higher and medium growth companies. The higher-growth companies on one end of the barbell may have more volatile growth from year to year, and the medium-growth companies on the other end of the barbell usually have a steadier growth outlook. Read more…
Portfolio Manager Lisa Myers is a bit of a whiz kid, having done everything from practicing corporate law in New York to teaching legal writing and research at Georgetown University Law Center. Today, she manages billions of dollars for Franklin Templeton. Beyond Bulls & Bears had the rare pleasure of an in-person chat with Lisa recently and got to learn a bit more about who she is beyond the desk.
Beyond Bulls & Bears: Lisa, your background is really quite varied and it even includes a law degree. We’re just curious – how is it you first came to be interested in investing? Read more…