The four things investors need to know, over the medium term:
Central banks have shifted focus from inflation to growth – with inflation ostensibly under control, central banks stand ready to provide stimulus to support growth.
The “New New Normal”… is the “Old Normal”- markets need less intervention from policymakers. No more zero rates and negligible inflation.
Can China break out of its Malaise? China has a huge impact on the global economy, including through the export of disinflation and as a consumption powerhouse.
Will geopolitics derail the economy? Geoeconomic fragmentation, elections and wars have the potential to upset economic and financial post-pandemic normalisation.
Wars have erupted, global consensus has ceased, growth is little and based on increasing piles of debt and “cooperation” has become a dirty word in politics. The world is not linear, we all know that. So why does it feel stranger than usual?
The philosopher Heraclitus (500 BC) wouldn’t bat an eyelid. “Everything is in flux, the world becomes but never is” he’d say, as if he knew that the earth is a weird looking pear-shaped object perpetually spinning and catapulting in space at 450,000 mph, while spinning around the sun and itself. Of course, Heraclitus saw empires rise and fall often in his life in the ancient Hellenic city Ephesus a crucial geopolitical point at the time. Ephesus’s master, Croesus, emperor of Lydia and issuer of the world’s first gold coin, was termed the “richest man in the world”, before being defeated by the Persians and almost burned at the stake. “Bless no one until their end” he famously quoted the lawgiver Solon in the face of defeat and certain death.
By comparison we grew up in a part of the globe that has been relatively peaceful for three generations. Perhaps it is because of this that we become so disturbed with conflict of any kind. Or because us in the West come from societies where children are protected, and where predictability is valued during the growth of an individual, so much so that we expect that sort of linearity to persist when we enter the world of adults.
For economists especially, a good world is one where countries agree on the benefits of global trade, where they do not compete but try to maximise economic outcomes. Where governments work with business interests in mind, and where technology is not a military but an entrepreneurial achievement. The economic narrative when things don’t go exactly that way, is one of doomsaying. Well, no one has yet accused us in this profession of being realistic.
The world is in flux and will continue to be. As we have often pointed out, in the meantime someone who stayed glued to the newspaper headlines and avoided investing has an opportunity cost of 46% in 22 months.
As portfolio managers, not economists, we understand the pragmatically and inherently volatile nature of global economic and political affairs. Historically, it is the peace eras that are the outlier, not war and certainly not strife.
How do we manage client money then, when that sort of volatility often threatens the well-being of the companies and country debt that underpin our portfolio?
We uncover themes.
The sheer chaos that is the global economy and global financial markets, can be managed only through the lenses of longer and shorter term themes. We have reviewed global financial markets and come to the conclusion that four themes are pertinent right now:
Central banks have shifted focus from inflation to growth – with inflation ostensibly under control, central banks stand ready to provide stimulus to support growth (i.e. cut rates). The shift in central bank focus is extremely important for the economy and markets going forward. Not so much because capital becomes cheaper. After all, the Fed continues to withdraw liquidity from markets at the pace of $50bn per month, and interest rates at 5% are just below nominal growth (Real GDP plus Inflation). Research suggests that central banks are more effective in signalling. A loosening cycle creates many opportunities for dovish signals towards financial markets, and thus opportunities for a strategic cyclical rally. Tactically, this creates opportunities but also pitfalls. If the market is in a dovish mode, then any hawkish signal can act adversely.
The “New New Normal”… is the “Old Normal”- markets need less intervention from policymakers. No more zero rates and negligible inflation. A key change that we have often noted is that the US central bank, for the first time since its creation in 1913 has decided to cede some of the power it has accumulated, and intervene less in the markets. While no two eras of the economy and central banking are the same, a subject which we heavily explore in our quarterly, a “return to normal” means that we expect lower correlations between asset classes, lower returns on equities (without the zero-rate turbo boost) but higher returns when we get the positioning right (and heavier penalties when we get it wrong).
Can China break out of its Malaise? China has a huge impact on the global economy, including through the export of disinflation and as a consumption powerhouse. China is the biggest question mark in 2024 and possibly 2025. The data suggests that it is slowing down, but we don’t really know by how much. At the current pace, western central banks and economies benefit from China deflating the world. However, if the pace of the slowdown becomes more pronounced, then this could have a negative effect on global growth for the next two years.
Will geopolitics derail the economy? Geoeconomic fragmentation, elections and wars have the potential to upset economic and financial post-pandemic normalisation. Geopolitical risk is decisively non-linear. It is not impactful until it is, and then becomes systemic. We are not professional historians, and our current view is that current geopolitical turmoil is within historical norms, and as such may not cause significant systemic risk for financial market (which most of the times is endogenous). But what if geopolitical tensions rise beyond the boiling point and do become systemic? Are we heading towards that direction? This is a question we need to keep in mind. An old saying suggests that to make markets one has to either be the first in (usually hedge funds and private investors), be the best, or be the first out of the door. Systemic risks are by definition non-manageable, but portfolio managers need to be aware and mitigate some of the damage.