Kaan explains why geopolitical risks remain a key driver of the economy and markets despite some recent de-escalation.
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U.S.-China trade tensions appeared to have eased and the risk of a no-deal Brexit has diminished. Can we take a break from focusing on the impact of geopolitical risks on the economy and markets? Not yet. We in fact expect more twists and turns in coming months, and see geopolitical risks staying elevated in the longer term. Raising portfolio resilience is critical against this backdrop, we believe.
Our Aura geopolitical risk dashboard helps track geopolitical risks and their potential market impact. It features both data-driven market attention trackers
(Aura geopolitical risk indicators, or AGRIs) and judgment-based assessments of our top 10 risks. The Global trade AGRI has historically showed a negative relationship with the world’s trade growth. A sharp rise in the AGRI in 2018 preceded a steep decline in the growth of global trade. The AGRI has since stayed at elevated levels and trade growth has languished. See the chart above. This underpins our view that trade tensions and other geopolitical risks have become key drivers of the global economy. Relatively high market attention to these risks suggests they are likely priced in to some extent.
Geopolitical risks have come to the fore in 2019 as a key market and economic driver, as detailed in our recently updated Global investment outlook. The marked escalation in the U.S.-China conflict in particular has injected additional uncertainty into business planning, threatening to further weaken economic activity. Markets breathed a collective sigh of relief after the U.S. and China ended the latest round of trade talk with more conciliatory gestures. Yet no agreed text was produced. The U.S. is maintaining all existing tariffs on Chinese goods and is set to launch a new round of tariff increases on Dec. 15. A
key signpost: The U.S. and China are aiming to agree on the text of a limited trade deal for the two countries’ leaders to sign at the Asia-Pacific Economic Cooperation (APEC)’s summit on Nov. 16-17. More senior-level meetings are required to achieve the goal, likely bringing more twists and turns. We may see a temporary truce heading into 2020 but view the U.S.-China competition as structural and long-lasting. Tensions between the two countries are broadening out to include technological and financial dimensions.
Elsewhere, markets got more optimistic that the UK would not crash out of the EU, after both sides agreed to a new deal. The British pound has rebounded sharply from early October lows. Yet any resolution still faces hurdles. The UK Parliament in a Saturday sitting voted to withhold its approval for the deal until relevant legislation is passed, forcing the UK government to ask the EU for an extension to the Oct. 31 deadline. Our base case is that Parliament ultimately passes a deal, as early as this week or possibly after a general election. The range of outcomes remains wide, but we see the tail risk of a no-deal Brexit as very unlikely.
Geopolitical frictions will remain a powerful driver of the global economy and markets despite the apparent easing in some risks recently. We expect a pickup in global growth in the next six to 12 months as policy stimulus gradually makes its way to the real economy. Yet we could see bumps on the read in the near term, as economic data remains weak and geopolitics uncertain. This suggests we should be thinking about ways to protect portfolios against potential risks. We favor the more defensive parts of the U.S. equity market, such as the min vol and quality style factors. We also see government bonds continuing to play an important role in building portfolio resilience – even at low yield levels.
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