Templeton Global Equity Group has a long tradition of bottom-up investment management, yet portfolio manager James Harper has to keep a top-level perspective on macroeconomic and geopolitical factors that impact his funds. That’s quite the responsibility, and even more so this year when markets have proven particularly volatile. Of those factors, key for him right now is the prospect of increasing interest rates and inflationary pressure.

“I think we are in a very interesting transition period – there’s a lot of uncertainty,” he says. “There’s an argument about whether we’re still seeing synchronized growth, or whether we’re at the beginning of the end in terms of this economic cycle. My personal view is that we will see inflation come back.”

In Mr. Harper’s opinion, a combination of low unemployment, tax cuts and record profitability in the US corporate space has created the perfect conditions for inflation, which in turn should lead to rising interest rates by the Federal Reserve.

The Fed maintaining that path is no guarantee, however, particularly with the threat of a global trade war looming.  “It’s the one thing that really keeps me awake at night in terms of where we are positioned,” says Mr. Harper. “We are positioned in the portfolio for steady continued growth and for a gentle rise in inflation and interest rates, but if the trade war leads to lower growth and higher inflation, we feel that our exposure to financials and materials will stand us in good stead””

Predicting policy decisions at the White House has grown increasingly difficult, and Donald Trump’s protectionist approach to trade has been a clear departure from his predecessors.

“One hopes that cooler heads prevail, and this is an initial stance to get what he wants,” says Mr. Harper. “I don’t really know what Mr. Trump is going to do, but I think his negotiating style is very aggressive initially – go in with all guns blazing – then maybe step back a little bit and negotiate.”

Should a situation arise where the US cannot find common ground with its international partners, then equity investors need to ensure they are protected on the downside, advises Mr. Harper.

“What could derail the scenario of gently rising interest rates, which would be relatively good for equity markets, is lower growth, driven by protectionism,” he says. “In that scenario, you still get inflation due to the importation of inflation in the form of tariffs, but the lack of free trade may dent global growth prospects.”

Volatility returning to the marketplace has been another major talking point of 2018. While investors may see this as a negative, given the low-volatility/high-returns of 2017, Mr. Harper points out why this can work to your advantage when using active management.

“In a low volatility environment, you tend to have relatively high correlations between stocks; that makes it harder for a stock picker to outperform,” he says. “So, I’m quite in favour of more volatility; I’m not talking 30% or 40%. Using the VIX as a proxy, it’s around 12–13% – that feels about the right level.”

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