Global markets face a difficult balancing act, according to Franklin Templeton’s Colin Morton, who warns faster-than-anticipated interest rate hikes could put the brakes on the bull run in equities. 
Morton (pictured), lead manager of the £521.4m four FE Crown-rated Franklin UK Equity Income fund, said until recently the investment backdrop had been exhibiting “Goldilocks” conditions, where inflation wasn’t run too hot for markets nor too cold with low economic growth.
“We’re in a nice situation where growth has recovered quite nicely and inflation is reasonably low; interest rates, although they’ve gone up a bit, are reasonably low and that’s a pretty supportive environment for equity markets,” he said.
However, Morton noted the distorting effect that stimulative quantitative easing programmes have had on markets as “some of that very easy money that has been around for a number of years [has been] taken out”.
The fund manager said equity markets face a “difficult balancing act” given the uptick in global growth, low inflation and relatively low interest rate environment.
Indeed, recent volatility shows how sensitive markets are to any suggestions that inflation could rise.
Performance of major indices YTD
Source: FE Analytics
“I’m just warning that we’re on a tightrope of some degree,” said Morton. “If inflation starts coming back a bit faster than people think, interest rates may rise further which obviously then means that equity valuations may come under pressure.
“I don’t think anyone would argue that equities are massively cheap relative to history but the point is we have to be very careful here.
“If things tick over to being a bit too hot, you could see bond yields rising quickly and interest rates rising quickly and that could really put the brakes on this market.”
He added: “You have to be a bit careful about what you’re looking for but at the same time it’s obvious that things look a bit better than they have for some time with the global economy.”
However, while the near-term outlook for the global economy seems to be improving there are still question marks over the UK.
“The UK is a little bit of a special case,” Morton said. “I know the political parties and all the people who voted to leave [the EU] keep saying we haven’t had the negative downturn that a lot of the people predicted straight after, and that’s true.
“But undoubtedly the UK economy is performing worse than most other economies now. If you look at the G7, the UK is probably the worst-performing.”
The UK economy has faltered, he said, as it deals with uncertainty caused by ongoing Brexit negotiations.
However, there may be some potential bright spots, particularly in UK consumer cyclical stocks. Morton noted that sterling dived against the dollar after the referendum, putting pressure on the sector.
Performance of sterling vs dollar since EU referendum
Source: FE Analytics
“If you think about what happened after Brexit and the 12-18 months afterwards, the pound went from £1.45 to £1.20 [against the dollar], inflation went up to 3 per cent and average earnings were running at 2 per cent,” he explained.
“We had this squeeze on real wages for the guy in the street at the same time for companies that were selling products in the UK – who generally bring them from overseas – were having to pay more for that product.
“So, UK domestic stocks have been trying to deal with higher import costs, at the same time higher utility bills, business rates went up in 2016/2017 which a lot of them weren’t happy about.
“I don’t want to call it too early, but some of those things may start to reverse.”
He said: “The dollar has been very weak, as they’ve on gone more of a growth offensive allowing the deficit to rise, which is more of an American strategy.”
Sterling has also strengthened as more progress has been made in Brexit negotiations, including the putting in place of a transition agreement, said Morton.
“I don’t know what happens now, but the market thinks Brexit is likely to be softer than some people were worried about,” he noted. “Because of that we’ve seen the pound rally above £1.40 and that’s good news, to some extent.”
The Franklin Templeton manager said the UK could reach a “crossover point” later this year, where inflation starts to trend downwards and low unemployment helps stimulate wage growth.
“You have to be very selective but it could be a bit better period for consumer cyclicals than it has been for the past year or two,” he said.
On a long-term view, the manager is more bearish about growth adding that the global economy is unlikely to get back to pre-crisis levels.
“We’ve still got a huge amount of outstanding debt globally, which means you can’t gear up dramatically which is what have done in the past to help growth,” explained Morton.
“Of course, if interest rates go up the cost of that debt will go up and we have to watch that carefully.”
He said the threat of deflationary forces in the form ageing populations and the disrupting impact of technology also pose challenges to global growth.
“Life is still not easy; there are still a lot of bigger forces at play and it’s going to be difficult to get back to the super growth rates that maybe we’ve seen pre-crisis,” he said. “But it does look like we are in a better place than we were 12-18 months ago.”
The manager added: “It’s been a long time since Europe, emerging markets, Japan and the US all seemed to be ticking up in the right direction together.”
Morton’s Franklin UK Equity Income is a top-quartile performer over three and five years, although it underperformed the IA UK Equity Income sector average during 2017.
Over three years the fund has delivered a total return of 24.86 per cent, compared with a gain of 21.81 per cent for the FTSE All Share index and a return of 19.23 per cent for the sector average, as the below chart shows.
Performance of fund vs sector & benchmark over 3yrs
Source: FE Analytics
The fund, which Morton manages alongside FE Alpha Manager Ben Russon and Mark Hall, has an ongoing charges figure of 0.54 per cent and a yield of 4.40 per cent.