Charting an investment path through the fog

While in 2017 financial markets largely ignored geopolitical risks, as they were more inclined to read the Goldilocks narrative, this mood now appears to be changing. In an environment that is already becoming more volatile, amid less accommodative central banks, demanding valuations, endogenous/technical new features of the market (liquidity deteriorating, crowded trades), a significant shift in fundamentals is not required to trigger market movement.

A butterfly may do the trick. At the time of writing, geopolitical events are dominating the news flow. These new tensions come at a time when trade frictions continue to be in the spotlight. On top of this, there are multiple hot political flashpoints. The first is the US/China relationship, where the focus is now on the practices in technology and intellectual property transfers. The second front relates to the US and Russia, given new sanctions and, most importantly, increasing tensions in Syria and instability in the Middle East. Regarding financial markets, the geopolitical noise is translating into frequent swings, inflows into perceived safe-haven assets (gold, sovereign bonds) and higher oil prices, with the consequence of added uncertainty in monetary policy actions. Central banks, in fact, are already facing the conundrum of how quickly to remove accommodation, as some recent economic data and surveys highlight some moderation of activity while inflation risk appears to be on the upside, potentially amplified by geopolitical and trade tensions.

We see three key ways in which investors can navigate through this ‘fog’. First is to keep a strong focus on the macro backdrop, separating noise from fundamentals. There are no signs of any major economic slowdown, though evidence is accumulating that global growth is losing momentum and has arguably peaked. US fiscal stimulus and pro-cyclical policy mixes in the Eurozone and Japan may impact the length and the amplitude of the cycle, but current cycle dynamics should continue. Going forward, it will be key to distinguish between what is merely cyclical and what is structural in order to manage the short-term risk environment while looking at long-term forces driving financial markets…