Geopolitics' clout on markets persists
<strong>By: BlackRock</strong> <b>Investment Institute</b>
<strong>Key Points</strong>
<ul>
<li><strong>De-escalated tensions: </strong>A perceived de-escalation in U.S.-China tensions and Brexit has driven up risk assets, yet we see geopolitical risks staying at elevated levels.</li><li><strong>Protectionist push:</strong> Signs that weakness caused by the protectionist push is spreading beyond manufacturing have cast a shadow on the growth backdrop.</li><li><strong>Data watch:</strong> The U.S. and euro area purchasing managers’ indexes (PMIs) due this week could offer a glimpse at the health of the global economy.</li></ul>
<strong>Geopolitics’ clout on markets persists</strong>
The impact of the protectionist push on the global economy and markets is playing out: Global growth is slowing, and geopolitical volatility has increasingly swung markets. A perceived easing of U.S.-China trade tensions and the risk of a no-deal Brexit has supported risk assets since early October. Yet we expect more twists and turns in coming months, and see geopolitical risks staying elevated in the longer term. We advocate for raising portfolio resilience.
<strong>Chart of the week</strong>
World trade growth and Global trade BGRI, 2014-2019
<img class="aligncenter size-full wp-image-140379" src="https://www.cover.co.za/wp-content/uploads/2019/10/world-trade-growth-vs-Global.jpg" alt="" width="569" height="410" />
<strong>Sources:</strong> BlackRock Investment Institute, with data from U.S. Customs and Border Protection, Statistics Netherlands and Refinitiv Datastream, October 2019.
<strong>Note:</strong> BGRI stands for the BlackRock geopolitical risk indicator. We identify specific words related to geopolitical risk in general and to the top-10 risks including global trade. We then use text analysis to calculate the frequency of their appearance in the Refinitiv Broker Report and Dow Jones Global Newswire databases as well as on Twitter. We adjust for whether the language reflects positive or negative sentiment. A zero score represents the average BGRI level over its history from 2003 up to that point in time. A score of one means the BGRI level is one standard deviation above the average. We weigh recent readings more heavily in calculating the average.
Our <a href="https://www.blackrock.com/corporate/insights/blackrock-investment-institute/interactive-charts/geopolitical-risk-dashboard" data-saferedirecturl="https://www.google.com/url?q=https://www.blackrock.com/corporate/insights/blackrock-investment-institute/interactive-charts/geopolitical-risk-dashboard&source=gmail&ust=1571816383252000&usg=AFQjCNEQcseVSUhJaHiiSRcr-6Ut8NGQQQ">BlackRock geopolitical risk dashboard</a> helps track geopolitical risks and their potential market impact. It features both data-driven market attention trackers (BlackRock geopolitical risk indicators, or BGRIs) and judgment-based assessments of our top 10 risks. The Global trade BGRI has historically showed a negative relationship with the world’s trade growth. A sharp rise in the BGRI in 2018 preceded a steep decline in the growth of global trade. The BGRI 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 <a href="https://www.blackrock.com/us/individual/insights/blackrock-investment-institute/outlook" data-saferedirecturl="https://www.google.com/url?q=https://www.blackrock.com/us/individual/insights/blackrock-investment-institute/outlook&source=gmail&ust=1571816383252000&usg=AFQjCNEzeQ81XJTUNHlL8ilElpqrhDCQ_Q">Global investment outlook</a>. 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.
Bottom line: 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 <a href="https://www.blackrock.com/us/individual/insights/blackrock-investment-institute/fixed-income-monthly" data-saferedirecturl="https://www.google.com/url?q=https://www.blackrock.com/us/individual/insights/blackrock-investment-institute/fixed-income-monthly&source=gmail&ust=1571816383252000&usg=AFQjCNG9NKkNxh3eLj1we279T7lJwBRZag">government bonds</a> continuing to play an important role in building portfolio resilience – even at low yield levels.
<strong>Market updates</strong>
<strong>Assets in review</strong>
Selected asset performance, 2019 year-to-date and range
<img class="aligncenter size-full wp-image-140377" src="https://www.cover.co.za/wp-content/uploads/2019/10/Assets-in-review.jpg" alt="" width="539" height="367" />
<strong>Past performance is not a reliable indicator of current or future results. It is not possible to invest directly in an index.</strong>
Sources: BlackRock Investment Institute, with data from Refinitiv Datastream, October 2019. Notes: The two ends of the bars show the lowest and highest returns versus the end of 2018, and the dots represent year-to-date returns. Emerging market (EM), high yield and global corporate investment grade (IG) returns are denominated in U.S. dollars, and the rest in local currencies. Indexes or prices used are: spot Brent crude, MSCI USA Index, the ICE U.S. Dollar Index (DXY), MSCI Europe Index, Bank of America Merrill Lynch Global Broad Corporate Index, Bank of America Merrill Lynch Global High Yield Index, Datastream 10-year benchmark government bond (U.S. , German and Italy), MSCI Emerging Markets Index, spot gold and J.P. Morgan EMBI index.
<strong>Market backdrop</strong>
A détente in geopolitical frictions on two key fronts – U.S.-China tensions and Brexit – has boosted risk assets. Yet signs that the drag on economic activity from the global protectionist push is spreading beyond manufacturing have cast a shadow on the growth backdrop. Major central banks have taken a dovish stance — the Federal Reserve has cut rates in line with market expectations, following the European Central Bank’s broad stimulus package. We expect a pickup in global growth in the next six to 12 months, yet see limits to how much monetary easing can be delivered in the near term. Monetary policy is no cure for the weaker growth and firmer inflation pressures that may result from sustained trade tensions.
<b>Asset class views</b>
<img class="aligncenter size-full wp-image-140378" src="https://www.cover.co.za/wp-content/uploads/2019/10/image003-10.png" alt="" width="730" height="807" />
