“Events, dear boy, events,” was the reply former prime minister Harold Macmillan gave when asked what are the greatest challenges facing a statesman. That famous quip could well apply to institutional investors today looking at the tumultuous economic and political outlook facing them.
There is no doubt that it is not just the events, but the number and scale that present a great deal of investor concern. In fact, it is quite unique that so many large events have converged at once: global economic uncertainty, war and geopolitical tensions stand out as likely to shape the approach of investors in 2024 and beyond.
Let’s begin with the worst-case scenario. And this is potentially very bad. This involves a world war. This would have seemed hyperbole a number of months ago, but the geopolitical heat has been turned up to scorching by the Israel-Hamas war.
It presents a highly fraught geopolitical situation. Every major geopolitical player stares off against another major opponent in this war scenario.
Ray Dalio, the founder of Bridgewater Associates, the world’s largest hedge fund, has warned that the Israel-Hamas war marks “another step toward international war”.
“It appears to me that the odds of transitioning from the contained conflicts to a more uncontained hot world war that includes the major powers have risen from 35% to about 50% over the last two years,” he wrote in a commentary. “These types of brutal war are more likely to spread than subside,” he said.
Investors and impact
This is a dangerous outlook. If correct, it poses a major test for investors.
Tom Stevenson, investment director at Fidelity International, has summed up his thoughts on how investors deal with such events. “Investors are generally not very good at understanding the impact of terrorism, war or other geo- political developments, even ones that have decades of precedent from which to learn lessons,” he wrote in a commentary.
So where should investors at least start?
“They should anticipate that, from time to time, bad things will happen, and they should regularly test what could go wrong with their portfolio, but also what could go right,” Stevenson says. “They should ensure that their portfolios are well diversified, across asset classes and geographical regions, to minimise the likely impact of a are-up in any one part of the world.”
There are points that investors can identify in an escalation scenario, says Richard Bullock, senior research analyst of global macro-geopolitics at Newton Investment Management. “The bigger risk for markets would arise if the [Israel-Hamas] conflict escalated to draw in regional powers such as Iran and Saudi Arabia, countries that also control significant volumes of oil supply,” he adds.
“Should the conflict persist, and the US become involved through weapons support to Israel, this would be likely to lead to further escalation and could draw in other great powers,” Bullock says. President Biden and his secretary of state, Antony Blinken, have been busy making statements about the need to avoid escalation for this very reason.
Muddy waters
Stepping back from the brink of war and addressing the mundane economic outlook for the UK and the rest of the globe, the situation is as clear as mud given that disinflation, deflation, inflation or stagflation all remain possible outcomes.
The focus is back on the Middle East, which could create a global inflation problem. “An escalation of Middle Eastern conflict could provide an additional source of inflation just as global central banks are beginning to show progress in getting inflation under control,” Bullock says, before adding: “The dynamics could be eerily reminiscent of the 1970s.”
The spectre of the 1970s haunts many outlooks. This is true of Shweta Singh’s view, with the chief economist at Cardano’s outlook showing a higher global interest rate environment starting to bite, tighter credit conditions weighing on housing markets and on corporations’ capital expenditure plans as well as on consumer activity. Furthermore, evidence indicates that corporate bankruptcy rates have started to climb.
“The prevailing consensus may be overestimating the strength of the present underlying growth momentum,” Singh says. “Accordingly, while our expectations are pushed out a little further into the future, we expect the onset of a US recession in mid-to-late 2024.”
Ahead of this downturn in the US, Singh expects a recession to commence in the UK, and in the euro area too, a little earlier in the year to come. This is not as bad as a world-war scenario, but it is pretty grim, nonetheless.
Back to the 70s
This means Singh sees the upcoming US presidential election and possibly a UK General Election in 2024 being held in the immediate aftermath of domestic recessions, a pretty unprecedented picture.
Except, of course, the relevant comparison is the return of a 1970s scenario, which keeps rearing its head. “Should 2024 play-out according to our expected pattern, a real dilemma will face the world’s central banks,” Singh adds. “While inflation is set to fall, it will remain elevated relative to central bank targets. Premature easing – a traditional counter-cyclical monetary policy response – risks giving away the gains made by the past tightening cycle.”
Here she therefore asserts that she is “very much in the higher for longer camp” and, accordingly, sees the overall interest rate environment as being a headwind well into 2024.
“Shallow post-recession recoveries are expected,” Singh adds. “Importantly, we don’t think that corporate earnings forecasts nor price-to-earnings ratios properly reflect this outcome. Equity markets start the year too high in our view.”
The geopolitical situation beyond the Middle East will also be big influence during the next 12 months. Daniel McCormack, head of research at Macquarie Asset Management, cites two ways this is likely to play out in 2024.
The first is in China-US relations. The second is the US election, set to take place in November, most likely between Donald Trump and the incumbent Joe Biden.
Great powers at play
On the first, McCormack says: “We are entering a period of great power rivalry where a rising power [China] is increasingly challenging the incumbent [the US]. Increasing trade tensions, greater use of industrial policy, investment restrictions and greater geopolitical tensions could all result, all of which could impact economic outcomes and returns.”
On the impact of the US election, he says: “Elections usually don’t matter much for investors,” before adding: “If the US moves in an isolationist direction after next year’s election – not guaranteed but possible – this would have profound implications for the international order and huge knock-on effects for the US’ allies and adversaries alike.”
In the longer term, the global economy could experience deglobalisation and slower supply side growth. “Slower or reversing globalisation, sluggish productivity across the developed world and demographics that are increasingly biting are resulting in slower supply-side growth for the global economy,” McCormack says.
In essence, more links to the 1970s: meaning more inflationary pressure globally, slower GDP growth and weaker returns across all equity asset classes over the next decade or so.
In the near-term, there are for McCormack three main scenarios for investors, and they all hinge on the US: a US soft landing, a mild US recession and a severe US recession. “These will all have different implications for interest rates and risk assets. However, we believe a mild recession is the most likely to the three,” he adds.
It is bad news when that is the best news.
Russia’s having a gas
Jose Pellicer, head of investment strategy at M&G Real Estate, also identifies geopolitical risks on different fronts. Firstly, there is Europe. “Western-friendly nations bordering Russia as well as other European states previously heavily reliant on Russian gas imports now carry a higher risk tag,” he says.
In addition, like others, Pellicer says conflict in Ukraine and an escalation of tensions in the Middle East are likely to have a negative impact. But he cites specifics: with an impact “on commodity prices and construction costs and could well result in greater investor caution when considering developments,” he says.
And then there is Asia, which inevitably includes America. “Worsening political relations between the US and China – and their respective allies – are likely to have economic consequences,” Pellicer says. For example, Pellicer cites specific regulatory changes within China itself “which could make it more difficult to divest or repatriate existing overseas investments in the future.”
Pellicer also subscribes to the school that does not expect rates to fall anytime soon. “We have entered a new era where interest rates will be higher for longer. For now, there is no going back to the lower rates of the last decade.”
Not exactly a return to the 1970s, but more of a clear fork in the road that creates new challenges for investors.
Investors, therefore, will need to adapt, with recession remaining a real threat in some markets. “We may also start to see a more defined, two-bloc global currency scenario with the long-term dominance of the US dollar and associated currencies challenged by the Chinese yuan,” Pellicer says.
Fiscal fluctuations
Investors should also keep an eye on fiscal shifts, according to Daniel Morris, chief market strategist at BNP Paribas Asset Management. “Beyond global economic uncertainty, war and geopolitical tensions, investors should closely monitor fiscal policy changes, such as potential adjustments in the primary fiscal deficit in 2024,” he says.
Additionally, he notes other economic and political areas to keep an eye on. “Factors like the impact of monetary policy tightening, changes in credit provision and the winding down of subsidies for climate change as well as infrastructure, microchip and electric vehicle investments in 2024 can significantly shape investor approaches,” Morris says.
He then adds to his scenario list. “Investors need to consider scenarios involving further escalation in geopolitical tensions, the continuation of quantitative tightening and the potential impact of a slowdown in credit provision,” Morris says. “The scenarios should also account for variations in long-term treasury yields, potential shifts in central bank policies and the evolving dynamics in sectors like technology, driven by artificial intelligence-related investment booms.”
Rethinking geopolitics
But for Tapan Datta, partner in global asset allocation at Aon Retirement Solutions, we need to keep geopolitics in perspective. “A note of caution is needed which is that it is easy to overstate the importance of geopolitical events on market conditions,” he says.
“While lots of major market moves have been occurring since the outbreak of hostilities in the Middle East in early October, the conflict cannot be held responsible for them. The lesson is that unless geopolitical conflict impacts the major global growth engines – G7, or at the very least, G20 – markets will typically decide to ignore them,” Datta says.
However, he notes that markets will take notice if there are simultaneous geopolitical events that could in combination bring a “material” impact. “A dual escalation of the Ukraine war and a widening Middle East conflict, to take an example, will be much harder to bypass,” he adds.
While acknowledging that there is no shortage of geopolitical event risk that would have the potential to destabilise markets in 2024, Datta says: “Their impact would have to be assessed on a case-by-case basis.” So on this outlook, we should not get carried away.
The importance of America
He instead makes the point about the importance of the US economy as a global growth engine, making impacts involving the US more material to markets. Essentially, some geopolitical players are more important than others.
“An escalation of US-China tensions beyond the current ‘cold’ technology war and a return to power of Donald Trump in the US presidential election late next year are two that come to the forefront when considering such market-moving event risks,” Datta says.
One of the more destabilising possible scenarios would be a combination of economic and geopolitical events that bring significant impact. Taking one example, even though a possible second Trump presidency only takes effect in 2025, markets will attempt to anticipate those effects much earlier, Datta says.
“If the likelihood of this happening looks to be increasing through 2024, markets will react weeks or even months before the November election,” he says.
There is a high element of unpredictability here on what policy changes will happen in 2025. But Datta has a stab, looking at the potential outcomes.
“If the US economy is already struggling under a prolonged period of high interest rates, the raised probability of a new round of unfunded tax cuts could destabilise the US bond market – given its strong disquiet over existing large fiscal deficits – driving yields higher, amplifying negative trends in the US economy,” he says.
Parallel scenarios
This scenario offers an interesting parallel with the ill-fated Truss prime ministership in the autumn of 2022. In a similar vein, a major ramp up of US defence spending that becomes necessary to contain conflicts in other parts of the world could also bring problems in rates markets for similar reasons.
Datta then adds additional observations on risk scenarios and how investors should react. “It is worth noting that any rise in uncertainty over event risks that could be material to global economic conditions comes through inevitably in higher market volatility which investors would be wise to allow for as a kind of ‘sidebar’ to considering event risk in markets,” he says.
Datta also notes there are a number of economic scenarios that could be troubling for markets even if geopolitical conditions turn calmer. “For instance, the impact of the big rise in interest rates in 2022/23 is yet to fully feed through and is still somewhat unpredictable. Investor caution on this is well warranted when it comes to assessing the risk of things going wrong that would bring about a significant economic downturn or recession.”
Of course, it is also true, he adds, that the global economy could muddle through, with geopolitical risks staying on the sidelines. “Which is perhaps the best scenario to hope for. As usual, investors need to consider the possibility that things go right rather than wrong, just to keep perspective,” he adds.
Risks and opportunities
Whether it is geopolitics or a replaying the 1970s, it is a challenging environment for investors. A challenging macro-economic backdrop doesn’t mean a dearth of investment opportunities. Quite the opposite, says Wei Li, global chief investment strategist at the Blackrock Investment Institute.
“Higher macro volatility is translating into greater divergences in security performance relative to broader markets. That calls for much greater selectivity and more granular views,” she says. “Harnessing forces shaping our world will also offer abundant investment opportunities. It all boils down to what’s in the price.”
But the higher for longer issue is also important for investors, Datta says. “We have moved into a lasting environment of higher interest rates than those seen in the past decade, the full economic and market drags of that will take time to feed through which argues for a more careful approach to investor risk-taking,” he adds.
“At present, it is hard to argue from current market pricing that particularly negative outcomes are being allowed for,” Datta says. “A broad spread of investments with moderate risk taking – somewhat below normal allocations to risky assets – and building in some protection from adverse scenarios through less market-sensitive strategies looks sensible for 2024.”
Like many, Datta sees private markets offering opportunities. “Private markets are still in the process of lagged adjustment to developments in public markets, but much as with public markets, debt should be favoured over equity on the basis that after inflation return prospects have improved considerably in the past 12 to 18 months.” However, he notes the extent of underlying credit risks taken will need close monitoring.
The biggest prize
Then there is what Daniel Yergin termed in his book the biggest prize: oil. Given the new global environment, oil price forecasts have been revised, says Gonzalo de Cadenas-Santiago, executive director at MAPFRE Economics, seeing an increase to an average of $87 (£70) per barrel, giving way to a fourth quarter peak of $101 (£81) per barrel by the end of the year.
In turn, he notes, a simulation of a higher long-term trajectory returns an average that remains above $90 (£72) per barrel in 2024 and a later convergence in the medium term.
“This assumption results in a more pronounced period of stagflation in 2024, but with more significant implications for economic activity than for price dynamics,” de Cadenas-Santiago says.
“The stressed scenario assumes a more pronounced and sustained oil price shock for most of 2024, due to worsening tensions in the Middle East,” he adds. “This supply shock translates into a more rigorous stagflation outlook, with implications for economic activity and price dynamics.”
Shareholder challenge
Daniel Peris, historian and author of the soon to be published The Ownership Dividend, says the political and economic trends and influences we are seeing should be put in a wider context. “Milton Friedman’s shareholder capitalism is being challenged by a broader European stakeholder approach taking into account factors beyond just capital returns,” he says.
Peris’ view is that on-shoring, friend-shoring, and near-shoring mean the model of “extreme globalisation” will have to be altered. “Expect to see more local and national, and less global. Expect more regulation rather than less regulation,” he says.
As with much of the outlook going forward, the political situation in the US is going to be fundamental. “The politics in the US may end up being the most important one for investors,” Peris adds. “The utter lack of trust in our political institutions right now runs the risk of bleeding over into the investment realm.”
Offering a further warning, Peris says this trust factor in the new political economic paradigm will play out over years, if not decades. It is no passing fad. In the meantime, from a narrower US stock market perspective, more specific outcomes associated with the end of the so-called neo-liberal order are likely.
The first is consistent with the end of interest rates declining. “The resulting return of material risk rates will leave less room for the tricks of the trade that became so common during the final decade or two of the prior order: special purpose acquisition companies, unicorns, and accounting shenanigans to optimise earnings per share should become scarcer,” Peris says. “Some mean reversion in US corporate margins from the advances of the past two decades is also likely.”
And then there is the idea of the cash nexus. “The end of declining interest rates on its own will mean assets will need to compete on a more normal cash-yield basis,” Peris adds.
But the new political economy will provide another reason for an improved cash nexus of investment: a different level of trust. “The post-neo-liberal order will likely entail less trust in corporate executives, and greater insistence by investors on a tangible return for their capital,” Peris says.
This all results in a near future where investors face numerous risks to navigate but opportunities also exist if investors look hard enough, amidst the turmoil.
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