As inflation cools, a brighter outlook for yield and emerging markets

This article was produced in partnership with Franklin Templeton.

Western Asset Management is a 52-year-old investment firm with offices on three continents and more than $400 billion of assets under management.

But ask portfolio manager Mark Lindbloom to describe Western Asset, and he doesn’t refer to either the company’s impressive size or its success.

“We're humble,” he says. “And we’re introspective, because the markets are tough and there will always be bumps in the road. But we’re also flexible and adapt to change, and over the years this has helped us come out ahead.”

As a specialist investment manager of the asset management giant Franklin Templeton, the Pasadena, California-based Western Asset plays a key role in providing Franklin Templeton’s Canadian investors with access to fixed-income opportunities around the world.

Since opening their first Canadian office in 1957, Franklin Templeton has been steadily expanding its stable of investment teams. From Western Asset’s expertise in fixed income – to teams that specialise in equities, real estate, venture capital and more – Franklin Templeton provides its investors with an impressive selection of investment opportunities.

During a recent interview with Wealth Professional from his office in Pasadena, Lindbloom said Canadian investors should be feeling increasingly optimistic after a bumpy 2022.

Drawing upon his 44 years of experience in the markets, Lindbloom shared his outlook on inflation, the economy and the attractive investment opportunities unfolding for the Franklin Western Asset Core Plus Bond Fund. 

Inflation and GDP

One of our first questions for Lindbloom is a question on everyone’s mind: where do inflation and interest rates go from here?

“The worst is behind us,” he says. “We've seen peak inflation in the US and it’s moving in the right direction. How far does it come down and how long does it take? Our best call right now is 3.5% to 4% for core CPI at the end of 2023.

“That’s progress but we don't see inflation declining into the Fed’s target zone of closer to 2% until 2024.”

On the economy, Lindbloom, who also serves on both Western Asset’s US Broad Strategy and Market & Credit Risk committees, says income gains have been impressive and that’s helping to hold up consumer spending.

This provides a foundation for economic growth ahead, though it could sit on either side of zero and possibly slip into a shallow recession. He says very few people are talking about a deeper recession.

But Lindbloom also sounds a note of caution. In line with the humble approach to the markets he described earlier, he tempers his optimistic outlook for inflation and growth with a couple of concerns.

These concerns include the failure of several US banks and the extraordinarily rapid pace of interest rate hikes over the last year.  

Banks and rapid rate hikes

The recent failure of Credit Suisse and several smaller US banks has some observers drawing comparisons to the financial crisis of 2008. Lindbloom said it’s understandable that the failures have stirred up memories of the previous crisis.

“It’s human to pull back and retrench,” he says. “You wonder about your counterparty, the quality of collateral, lending standards and the impact of future regulations. These are unknowns that suggest the outlook could be a little bit more sinister.”

However, Lindbloom says there’s a clear difference between what’s happening today and what occurred in 2008, adding that he’s comfortable maintaining exposure to large US banks and some “very select” regional and European institutions.

Lindbloom also touched on concerns about the sharp rise in interest rates since 2022, suggesting the rapid pace of these increases has put the economy in uncharted territory in terms of their potential impact.

“We're at the highest rates in 15 to 20 years after the fastest tightening I've seen since 1981, so it’s bit of an experiment to see how this affects behaviour and the economy.

“It’s possible this could be a policy mistake, and we may see a bigger slowdown than expected,” he says.

This uncertainty applies to the Fed as well, Lindbloom adds. “Their heads are spinning, and they’re concerned about the economy to the point of actually mentioning the ‘recession’ word which they don't like to do.”

Lindbloom says the Franklin Western Asset Core Plus Bond Fund has adjusted to some of these concerns. The fund is reducing exposure to riskier assets like high-yield bank loans and strengthening its exposure to investment grade assets.

Emerging markets

Western Asset is a global firm with offices in Asia, South America, Europe and Australia. Asked about emerging markets, Lindbloom sees opportunities for Canadian investors as China re-opens and a number of developing countries wrap up their fight against inflation.

“We're quite optimistic on emerging markets,” he says. “China is doing pretty well after performing a 180 on Covid and coming back online very quickly. Our Singapore office is predicting 5% to 6% growth in China this year, and we feel that's going to have a knock-on benefit for other emerging market countries.”

Lindbloom also says central banks in many emerging market countries have done a better job on inflation than their peers in developed countries. They responded to the threat of inflation early because they don't have the luxury of having the dollar, euro or yen. Their currencies and economies are vulnerable unless they act quickly and decisively.

Lindbloom takes a moment to say he doesn’t like the idea of lumping so many countries under a single banner like ‘emerging markets.’

This is unfair and imprecise, he says. “When we manage risk, it's very specific, it's country by country. It's our analysts looking at sovereign and corporate debt within those countries to find value.”

As examples of countries that Western Asset favours, he lists Brazil, Mexico, Indonesia, India and some in Central Europe.

“We feel emerging markets will shine in 2023, and so far that has been the right call.”

Bringing our discussion back to North America, Lindbloom highlights some of the opportunities he sees with investment grade corporate debt.

“We feel that single A and triple B investment grade corporates look fair, and we're picking and choosing the sectors and securities we want to own. We’re not just buying an index. This is an overweight for us.”

Looking at occupancy and cash flows over the next 2, 5 and 10 years he says spreads are starting to look quite attractive. “We're leaning a lot towards those sectors,” he says.

Lindbloom is less enamoured with commercial real estate. “There’s a lot of fear in that market right now, and we're very careful about the commercial mortgages we want to buy.”

As our interview draws to a close, Lindbloom reiterates that after a difficult 2022 there is much for Canadian investors to be optimistic about in the year ahead as inflation cools and yields return to where they’ve been historically.

He says Western Asset and the Franklin Western Asset Core Plus Bond Fund are perfectly positioned to capitalise on the opportunities that are emerging in both North America and select markets in the developing world.

“We have the landscape covered here at Western Asset,” he says. “I've been here going on 20 years, and it's been the best fixed income shop I've worked with in my career.”

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