Name: Navigating a Turbulent World
Uploaded: 2023-12-06T16:40:00Z
Duration: 15 min 37 s
Description: From hot wars to trade disputes, geopolitical turmoil is reshaping the global economy in profound and unexpected ways. Seema Shah, Principal Asset Management discusses how the shifting macro dynamics and global tensions are impacting investments.

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From hot wars to trade disputes, geopolitical turmoil is reshaping the global economy in profound and unexpected ways. Seema Shah, Principal Asset Management discusses how the shifting macro dynamics and global tensions are impacting investments.

https://m.wsj.net/video/20231206/2187b0a0-a910-498c-9db8-372988fb78b9/1/hls/manifest-hd-wifi.m3u8

Navigating a Turbulent World

Thank you so much, Lauren. Our conversation with Seema is gonna focus on how today's turbulent world is impacting the investment landscape. Thanks so much for being with us, Seema.

Great to be here, thank you.

So, how do you assess, how do you prioritize the various geopolitical risks that are out there at the moment, and what factors are you looking at when you make your assessment?

Well, it's a really timely question 'cause actually 2024 is probably gonna be the most, the highest number of democratic elections in history. So it's fair that investors go into 2024 really trying to figure out, decipher what geopolitical events could do to portfolios. The key takeaway though is actually when you look back at analysis, geopolitical events rarely have a sustained market impact. So if I take you back to the Russia-Ukraine war, The market impact lasted for only about two weeks and then it took just two or three days to recover some of those market losses. And typically what happens is it's only if there is a fundamental factor which is affected. So let's say it's the inflation or the interest rate outlook which is really affected by the geopolitical event, which rarely does that happen. So what you need to be looking out for is, is there an impact on inflation, is there an impact on central bank policy? And if there is, then maybe it's worth positioning portfolios, but typically it's better just to kind of stone hold and try not to try and time market highs or lows around geopolitical events.

There are of course many people who will time them around central bank decisions, though. So when do you think central banks are gonna definitively conclude their hiking cycle and what kind of underpins that view?

So I do think that generally speaking, most of the developed markets that central banks have stopped hiking, they're already at their peak, but we're still in that stage at the moment where central banks are not quite giving a very clear message about whether or not they're done. And certainly it works for them in terms of maintaining a slightly hawkish message, and he was holding and dangling that threat of another hike out there in order to make sure that financial conditions don't continue to loosen. We do think though that once you start to see very clear signs of inflation moving towards target, they don't need to get to target, but as long as they're within the realms of the central bank target and that's accompanied by some kind of economic weakness, typically on the job market side, that to us would be very clear green signal that you're gonna see rate cuts coming fairly soon.

I don't wanna be too facile, but just as a rule of thumb, do you think that it's safe to say that if we get past the end of the year, maybe the very start of next year, without any further hikes from major central banks, then the worst of the kind of inflationary risks are now behind us?

So I think that should be the base case, but I think it's important that investors maintain some of the inflation risk that is out there, because historically what we have seen is you get one wave of inflation and then that is actually followed by a second round of inflation. So I think that does feed into policymaker reaction function. It's one of the reasons why they may maintain rates at these levels for a prolonged period before they start to cut. And we have to keep an eye on oil prices. That's gonna be one of the key inflation risks going into 2024. But the base case scenario should be if you get through to year end without any more rate hikes, we're pretty much done.

And you'll remember, I remember talking to you about it towards the end of last decade, we saw that trade policy, particularly in the United States, had a massive impact on market sentiment. As you look ahead to Q2 and beyond, you've got a US presidential election coming up. How do you think the positioning around trade policy could evolve, and do you think there's actually even a factor in the political debate in Washington at the moment?

Again, it's another one of those interesting questions that I think investors really do have top of mind because we have seen from previous elections that that trade policy did drive, at least partially drove some of the very significant market gains or market moves. So I think for 2024 election, it is still top of mind for the political debate. You're seeing it play out from the Democratic and Republican side. But I do think that investors have pretty much priced in the idea that between the US and China, tensions are likely to remain. There is some hope that it's gonna peter out a little bit, maybe slight improvement in relations, but generally speaking that tension is likely to persist. We do need to keep a watch if there is a new president in the White House that maybe there is a further deterioration in trade relations, but at this stage, it's just a case of tracking that and knowing that it's fairly priced into market expectations already.

So you've got investors pricing in this idea that the US and China decoupling is a fait accompli, it's gonna happen regardless. Do you think though that investors might need to shift their positions a bit further when it comes to expectations on broader global trade beyond that decoupling, particularly if there's a new resident inside the White House?

So I wouldn't necessarily move portfolios based on that. I think it's one thing to watch, if tensions deteriorate, we would expect that China policy makers would step in to provide a necessary stimulus to their economy. So I wouldn't necessarily move portfolios around that. I think there are bigger considerations around the election, maybe around fiscal policy, which could be more market moving than certainly the trade relationship.

You mentioned that geopolitics doesn't often lead to long-term impact particularly on market pricing, but what do you think the crisis in the Middle East that we've seen the last couple of of months means for the macroeconomic impacts that investors look at? Do you think that for instance, energy prices will be a relevant outgrowth of this crisis? Or are there areas that you are looking at particularly?

Yeah, as I said before, geopolitical events, it really has a sustained market impact if it really shifts fundamentals. So one of the key things that we will be looking out for with regards to the Middle East is does it have a sustained impact on oil prices? So are you seeing oil prices move up, move above the $120 a barrel and sit there for a while? If it does, then you should expect to see inflation expectations continue to move up and central banks would probably react to that with some concern. We know from time and time again there was talk about inflation expectations needing to be anchored. So if they become de-anchored, that could set the stage for renewed interest rate hikes. It is not the baseline scenario but that is one thing that investors do need to watch with regards to the Middle East conflict.

And one of the things we saw at early stage of this conflict was the United States positioning a lot of its military assets into the region seeming to send a message, look, please don't get involved if you're not already involved to countries like Iran, to Hezbollah or groups like that in Lebanon. Do you think that that action taken by President Biden and his administration may have helped to try and tamp down some of these economic concerns that people would've had around things like the oil price?

Well, it has been interesting to see oil prices decline in the last few weeks despite the conflict. And clearly investors have been reassured by the fact that the conflict hasn't expanded to this point. So I think there's a number of things that are playing into that. But I said, as you go into 2024, I think it's fair to say that given the fact that oil prices have moved down, maybe some of the risks are underpriced and in fairness, should maybe maintain some kind of inflation protection within their portfolios to take account of that.

What about climate and the interaction between energy and climate as many, many developed nations and developing nations move further along their transition journey? Are you seeing indications that some policies from governments, major governments in particular like the United States, are having an impact on energy prices, and with the follow through that has, of course, on inflationary concerns?

Well, that's interesting because that green energy debate does really play directly into some of the structural inflation drivers that investors are so focused on. We would expect that that transition does add to inflation, at least in the short term. Maybe in the longer term you start to see more of a deflationary aspect, but governments who are investing in infrastructure in order to help some of that green energy are probably inadvertently adding to some of the inflation concerns. And that will certainly play into the portfolio positioning and is one of the reasons that we do think investors should maintain some type of inflation protection, not just for 2024, in fact, but actually all the years beyond that as well.

And if we leave a aside instability in the Middle East, when we're talking about energy prices, are there other factors driving energy that you think investors over the next year or so really need to pay attention to?

Well it's a lot about capital and expenditure. So one thing that we are starting to see in the last couple of weeks as well is that some of the investment that went in in the US may be actually starting to play through and that could be one of the reasons why you've seen oil prices decline. So that is something that to keep an eye on, watching how government policies play out, how much they're investing, how much they're planning to continue that energy and infrastructure investment, because it may not play through in 2024, but the impact of that on oil prices and broader commodity prices could play out over a number of years. So we are looking at more of a five year horizon rather than just the immediate one year horizon from that regard.

And when you talk about infrastructure investment, we've obviously seen this huge, huge outlay by the US administration. Do you anticipate you'll see similar kind of investments by the European Union, by other sectors around the world, other governments thinking about how they can affect this transition?

It is a key debate between the US and the European governments, and maybe even some competition in regards to that too. So we are expecting to see continued focus. We've already seen the European government in any case, really focus more on that green energy than you're seeing in any other part of the world. So this still continues to be top of mind for them. The thing for Europe is to try and find the funds, and that's probably the biggest challenge for them given the various constraints that they have. But at least we do know that it is really top of the agenda for European governments, even more so than the rest of the world.

And those constraints in part driven by high government borrowing costs, no doubt itself driven by inflation and central bank decision making. Do you foresee a time where governments, particularly in developed parts of the world like the European Union feel they can start to up their public investment in some of these areas with all of the impacts that you've already outlined those might have?

Well I think what you've seen that meant is that there is a lot of market scrutiny on government spending, how they're spending it, where they're allocating it. So at this stage they're in a slightly difficult relationship with the market where we know that in many parts of Europe, you probably do need additional fiscal spending, whether it's on infrastructure for green energy or other parts of the economy. But at the same time, if you were to see that additional spending, you could see market scrutiny, markets almost penalizing governments for focusing on that additional expenditure. I would think that maybe 2024 is not the year to see spending coming through significantly in Europe, but maybe a little few years out, once you've got a recovery in play and maybe market scrutiny has diminished slightly, at that point you could see the green light for further spending. And that's not just for Europe, in fact, but that's also for the US as well.

And this is the big question obviously, where do you think investors should be looking to identify opportunities? You've got all of this turbulence in so many different areas, so many different financial silos. Where do you think investors should be looking for opportunities right now in terms of the outlook for the next 12 months?

So although there are a lot of geopolitical risks out there, as you said, there's a lot of considerations on the energy side, I do think that investors do have a fairly good opportunity still, and it's really key that they focus on the fundamentals. What is your baseline scenario? To us, the baseline scenario is telling us that although there could be a bit of an economic slowdown next year, the positive part of that is that it does open the door to rate cuts around mid-year, which has gotta be the key thing that investors are looking out for. So once you do see interest rate cuts, we should see risk flows into areas such as equities, maybe some parts of the small cap space, especially. Within fixed income you start to see actual income now for the first time in decades. So I think that going into 2024, this is probably one of the best opportunity sets available to investors in many, many years.

And do you think that kind of a reallocation away from equity towards fixed income given those returns you're talking about there, is something you are already seeing and you're expecting to see more of it?

We have already seen a lot of flows into fixed income in the past year or so, as you've seen yields move higher. But I think it's still got further to go because once upon a time fixed income was just considered as a tool for diversification. But now when you've got income back in it, fixed income is more than just a diversification tool, it actually becomes an attractive part of a portfolio. So I would expect that to be sustained. You could see additional flows there. But I also think that equities in a rate cutting environment probably do look a fairly attractive outlook.

And then another not too specific question hopefully, around equities. Are there sectors you think people should be focused on right now that perhaps they haven't been over the last decade? We've seen huge surge in a lot of the growth stocks, particularly around tech. Is that an area where investors should maintain their focus do you think? Or are there some little gems out there that people aren't maybe thinking about enough?

Well I do think that technology is a bit of a long haul. Their valuations are very expensive, but they do have the strong balance sheets, they do have the the strong cash flow, then investors are probably gonna need to maintain some focus on over the coming years as well because we're not really going back to a zero rate environment. Having said that, as you said, there are opportunities out there. So outside of the tech space, I do think that as you get to maybe more of a positive sloping curve, field curve, then financials become interesting again, you almost need to get past an economic dip first and then financials start to look attractive. The other area which is worth investors maintaining focus on is on the energy space. The geopolitical conflicts that seem likely to persist over the coming years does mean that energy is back in the spotlight and it will be volatile but there are probably opportunity for fairly significant gains in that space over the coming years. And then one other thing just to focus on for the very short term, we're probably beyond defensives. Defensives have not performed particularly well this year because of economic resilience. But as we get closer into 2024 and into the year, there is likely to be some type of slowdown coming through, and at that point, the healthcare utilities, those areas could do well in the short term before you start to see a recovery towards the end of '24.

Seema, we're gonna have leave it there. Thank you so, so much for all of those insights and for your time. Really appreciate it.

Navigating a Turbulent World

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