Last year was a perilous time for investors. Yet that tremulous market environment may not be a blip but the norm going forward. That is, if a theory around a geopolitical risk supercycle proves to be correct.
This suggests a ‘supercycle’ of geopolitical risk is in its early stages and so more market turmoil is on its way, with all the upheaval that it brings. This is a worrying prospect for many investors, although some will welcome the opportunities that volatility can create.
Evidence thus far suggests an analysis grounded on a geopolitical risk supercycle has much going for it. This is based on several converging factors that will shape the geopolitical and financial world going forward. It involves a comprehensive list of the emerging China-Russia partnership, NATO expansion, the Saudi-Iran diplomatic deal, US tech tariffs and industrial policy, a wave of global strikes and mass protests and the mega-election year of 2024 in many parts of the globe, creating mass uncertainty.
Tina Fordham, a geopolitical risk strategist who coined the ‘geopolitical risk supercycle’ phrase, says of it: “Based on 25 years of assessing the relationship between geopolitics and markets – there are few genuine ‘black swans’ and most risks are hiding in plain sight. If we don’t see them, it’s usually because we’re either not looking or in denial.”
Do investors see these risks in plain sight? Indeed, is the geopolitical risk supercycle theory valid? “The short answer is yes,” says Richard Tomlinson, chief investment officer at Local Pensions Partnership Investments.
From the fall
The shift to a geopolitical risk supercycle scenario should be seen in a wider context of changes taking place in the global economy. This wider context, Tomlinson says, dates back to the fall of the Berlin Wall.
“Since the late 80s, we had on-going globalisation, global powers focusing on a peaceful world, essentially on the positives: with some of the poorer parts of the world getting better o and world poverty decreasing,” he says.
But that is rapidly changing. The geopolitical risk supercycle outlook goes hand-in-hand with the idea of a new Cold War, according to a concept put forward by historian Niall Ferguson. “The tectonic plates between China and the US have been changing. It is becoming more of a battle of pre-eminence, economic and military power,” is how Tomlinson frames it.
In the wider historical overview, the so-called Washington consensus that dominated following the Second World War, with the creation of the IMF and World Trade Organisation to govern the global economy, is no longer so dominant. “China is now saying: ‘We are a superpower. We have a large economy and a large population’ and [the declining Washington consensus] is an evolution of that important development,” Tomlinson says.
New world order
Tom Donilon, chair of the Blackrock Investment Institute, puts it in starker terms. “We have entered a new world order,” he says. “Two major geopolitical and economic blocs – one Western-led and one led by China and Russia – are firming up and are increasingly in competition with each other.”
The fragmentation that’s ensued, Donilon says, has led to a dramatic reduction in geopolitical co-operation and the rise of a group of more assertive and important multi-aligned countries. This is reflected in the high ratings revealed in the Blackrock Geopolitical Risk Indicator, which tracks market sensitivities to geopolitical risks.
The indicator keeps the US-China strategic competition risk rating at a high level. “We see the trajectory of US-China relations as decidedly negative and believe it presents significant risks for investors,” Donilon says.
Tomlinson agrees. “The big relationship is the long-term evolution and relationship between China and the United States. Going back 10 to 15 years, there was a strong relationship between the two that worked – it had consequences, with US manufacturing hit hard – but there was a symbiosis there.”
That isn’t the case now. “There is a different political backdrop in the US and a different global situation,” he adds. “America is deliberately changing its geopolitical role,” Tomlinson says, adding that this is likely to have stark outcomes. “The world could easily divide into two power blocs, essentially amounting to authoritarianism versus democracy,” Tomlinson says. The risk indicator also maintains the likelihood of high tensions in the Gulf also being a component part of the geopolitical risk supercycle.
“The potential resumption of diplomatic relations between Saudi Arabia and Iran should support regional stability yet concerns over Iran’s nuclear program have raised the risk of a military confrontation in the Middle East to its highest level in nearly a decade,” Donilon adds.
And probably the most worrying assessment is Blackrock’s high likelihood rating for a Russia-NATO conflict. “We see no resolution on the horizon as Russia and Ukraine pursue spring offensives,” Donilon says. “We see a substantial risk of escalation in the most dangerous standoff between the West and Russia since the Cuban missile crisis.”
This is a stark assessment. And ramps up any geopolitical risk supercycle scenario to a potentially new, much higher level.
Getting colder
Unsurprisingly these risks are already rearing their head. They can be seen in the form of increasing structural headwinds, says Emiel van den Heiligenberg, head of asset allocation at Legal & General Investment Management. “These risks need to be viewed against a background of a deepening cold war between China and the US,” he says.
The seeds of this are already appearing. Under the geopolitical risk supercycle scenario things are only likely to intensify. In fact, other themes connected to it could be seen as the much-debated issue of deglobalisation and arguments about the de-dollarisation to name but two, which are resulting in, or a result of, global power shifts.
It means ideas expounded by American political theorist Francis Fukuyama in the 1990s, in which he stated the ‘end of history’, resulting in victory for liberal democracy are speedily being put into reverse. Liberal democracy is not the victor, but potentially in retreat.
A clear indication of the uncertainty wrought by the geopolitical situation is evident by a 2023 political risk survey by Oxford Analytica. This showed that last year, 68% of global companies bought political risk insurance – providing cover for wars, coups, government expropriations and other risky misfortunes. This is up from 25% in 2019.
The fear from the geopolitical picture is revealed amongst corporations in other ways. Compared to last year’s survey, respondents were far more likely to opine the worst-case scenario across geopolitical trend options.
The proportion who predicted deglobalisation would ‘greatly strengthen’ was 16% last year, but this has rapidly jumped to almost 50%. And the proportion who predicted decoupling from China would ‘greatly strengthen’ was 12% in 2022 but has since risen to 42%. These shifts are clear indications of where the global economy – with a strong reference to China – is going.
New era
What this means for investors is a clear re-assessment or even reconsideration of their portfolios. “The era is coming to a close when you owned multi assets and did not get hurt,” Tomlinson says. “With the global risk situation, now it is how domestically you focus.
“That shock felt in supply chains is a factor, as is ESG,” he adds. “It makes more sense to manufacture locally. It is almost like the moons are aligning for a more domestic focus.”
So based on geopolitics, the environmental concerns and the overall balance of the economy in the UK, Tomlinson says this makes a strong case for domestic investments. “It is not quite levelling up, but it is thinking about how the UK evolves from here. Is it possible that we can invest in real assets that support the UK economy? Yes, absolutely,” he says.
For Dan Mikulskis, partner at Lane Clark & Peacock, a consultancy, a revisit of asset owner allocations is much needed. “The fragmentation of the world economic system is something investors probably have to grapple with as they consider their capital allocation decisions around the world,” he says.
As the big trend of the past 20 years has been asset owners diversifying portfolios out of home markets and into global markets, usually including emerging markets and especially China. “For asset owners in the UK, this has generally been a benefit in terms of returns,” Mikulskis says.
A fragmented world
A huge re-think is needed. “Investors may need to reconsider the size of these allocations in a world which is more fragmented and where economic and financial sanctions might well be used which can trap capital or cause markets to close,” Mikulskis says.
“Of course, it’s also possible that markets may re-price to reflect these risks,” he adds. “And some investors might consider them to be a suitable reward, whereas others might consider them too binary a risk to run.”
Tomlinson also highlights a migration from financial assets to the real economy, with more focus on green infrastructure. “Then there are exposures that can survive different future world orders: US and Europe-based global corporations as well as real assets on the ground, the more robust conservative assets,” he adds.
Wei Li, global chief investment strategist at the Blackrock Investment Institute, says the situation demands more frequent portfolio changes by balancing views on risk appetite with estimates of how markets are pricing in economic damage. “It also calls for taking more granular views by focusing on sectors, regions and sub-asset classes, rather than on broad exposures,” she says.
Although, as many commentators have observed with recent market shifts, it is hard to assess the degree to which geopolitical risks are priced into the market.
Long-term risk
Acknowledging the importance of the issue, Mikulskis observes that geopolitical risk is something investors will need to adjust to going forward. “One important thing to remember is that over the long term, living with risk and uncertainty is key to long-term investment growth,” he says.
But Mikulskis adds a slightly different take. “In general, hedging risks, particularly broad and high pro le ones like geopolitical risk, usually comes with specific cost in terms of lower returns. Many geopolitical risks have loomed large over the past decade while global stocks have overall delivered great returns.”
In addition, geopolitical risk is difficult to sometimes fully assess based on three counts: it is difficult to forecast in terms of an overall outcome; timing; and the investment market outcome. “You need to get all three of those right,” Mikulskis says. “And it’s possible to get two out of three right, but still lose money,” he adds, highlighting the challenge for investors.
Ineffective forecasts
Geopolitics is also a topic that attracts a high level of coverage, which is not necessarily a good thing. “Investors have a near-constant supply of forecasts – most of which will turn out to be wrong,” Mikulskis adds.
Nevertheless, asset owners should, he notes, expect their active managers to be assessing the risks posed to their investments and whether these are being rewarded. So how long will the spectre of a geopolitical risk supercycle hang over the global economy and the investment world? Like Lawrence Oates’ walk: it could be some time.
“If you take the long view, these type of cycles are generational,” Tomlinson says. This in itself has clear implications for how institutional investors deal with a geopolitical risk supercycle. Investors therefore need to buckle down for a risk supercycle that will shape investment for decades to come.
Summing this up for investors is a quote from Sergeant Phil Esterhaus from the 80s TV show, Hill Street Blues: “Let’s be careful out there.”
TOP FIVE GEOPOLITICAL RISKS
1: US-China strategic competition
Issue at risk: China takes military action against Taiwan or asserts claims in the South China Sea by force.
Overall view: Military action not expected in the near term, but the risk could increase over time and subject to escalatory triggers.
2: Russia-NATO conflict
Issue at risk: Russia launches a large-scale invasion of Ukraine. The US and EU respond with financial, energy and technology sanctions on Russia.
Overall view: Russia’s invasion of Ukraine is the largest, most dangerous military conflict in Europe since World War Two.
3: Global technology decoupling
Issue at risk: Technology decoupling between the US and China significantly accelerates in scale and scope.
Overall view: Strategic competition between the US and China is driving global fragmentation as both aim to boost self-reliance, reduce vulnerabilities and decouple their tech sectors.
4: Major cyberattacks
Issue at risk: Cyberattacks cause sustained disruption to critical physical and digital infrastructure.
Overall view: The pace of cyber-attacks increases as the Russia-Ukraine conflict persists. Tensions in the Gulf could also lead to increased attacks by Iran.
5: Gulf tensions
Issue at risk: Iran nuclear talks collapse, and tensions escalate, raising the risk of a regional conflict.
Overall view: The risk of military action in the region is at its highest point in a decade.
Source: The Blackrock Geopolitical Risk Indicator
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