Franklin Templeton Strategist Says US Inflation Could Hit 4%, Fed May Cut Rates Once This Year

Hankyung-Wall Street Expert Group Interview

Stephen Dover, Chief Market Strategist at Franklin Templeton

Cuts Fed Rate-Cut Forecast to One From Two

Strait of Hormuz Shipping Disruptions Could Add Inflation Pressure to Food, Agriculture and Semiconductors

Investors Should Broaden Portfolios Beyond the M7 and the US Market

Sees Opportunities in South Korea and Japan, With Healthcare and Financials Also Attractive

The war involving Iran could push US inflation as high as 4% by the end of this year, as shipping disruptions in the Strait of Hormuz drive up prices not only for energy but also for agricultural goods, food and semiconductors.

Stephen Dover, Franklin Templeton’s chief market strategist, said in a Zoom interview on June 7 that he had expected US inflation to edge down this year from about 3% toward 2%. He now sees it at no less than 3%, with 4% possible in a worst-case scenario.

That has reduced the likelihood of Federal Reserve rate cuts. Depending on how conditions evolve, the Fed may even need to raise rates, creating an unfavorable stagflation scenario. Dover lowered his forecast for rate cuts this year to one from two.

Inflation pressures are also being reinforced by the prospect that oil prices may take considerable time to return to prewar levels. Rebuilding damaged refining infrastructure could take years, he said. Uncertainty over what happens next in the Middle East is itself affecting prices.

Dover said a disciplined investment strategy matters more than an emotional response in a market environment marked by high uncertainty. No one knows what will happen with the war, Iran or oil prices, but history shows discipline is especially important in such periods. Investors should watch market signals, especially the VIX, the volatility gauge often known as Wall Street’s fear index.

Over the past 30 to 40 years, when the VIX rose above 30, the median return one year later was about 23%, Dover said. When it climbed above 50, the return was about 30%, with a 100% hit rate. He advised investors to buy in stages during market selloffs, add more when volatility rises above 30, and consider more aggressive investment decisions when it moves above 50. He added that such periods are very unpleasant and difficult.

He also said short-term bonds offer investment opportunities.

By sector, Dover put healthcare first. Most job growth is coming from healthcare because of aging demographics, he said. Financial stocks would also benefit if interest rates fall, while defense is likely to become a structural growth industry not only in the US but also in South Korea.

Industrials, or value stocks, also look attractive if a recession is avoided. If a recession does materialize, growth stocks would likely perform better.

Dover also emphasized investing outside the US. He said he remains positive on Japan and parts of Europe. Europe’s economy is weaker than that of the US, but lower valuations make the region attractive. Since the start of this year, he has been advising clients to broaden their exposure beyond the US and the Magnificent Seven, including to South Korea. He said portfolios built that way had also performed well during the Iran war.

Stress in private credit, which has become a source of anxiety after recent redemption problems, is unlikely to spread into a systemic risk event, he said. Still, individual investors may assume they can withdraw money at any time even though private credit is illiquid. For retail investors, high-yield bonds may be a more rational choice than private credit because the market has improved in quality from its days as a so-called junk market, has shorter maturities and, above all, offers liquidity.

Dover also commented on the stronger dollar. The US currency has risen, especially against the South Korean won, because South Korea is more exposed than energy-independent countries due to its reliance on imported energy, he said. Still, the dollar has not surged as sharply as in past episodes when it acted as a haven asset. Over the long term, he sees a higher probability of dollar weakness over the next five to 10 years.

He remained relatively positive on US equities, saying the S&P 500 is targeting 7,000 to 7,400 by the end of this year, along with earnings growth of about 10%.

Park Shin-young, New York correspondent, Hankyung.com nyusos@hankyung.com