Markets in an era of clashing superpowers

ARE we entering a new era? And does it matter?

The world is a mixed-up place at present. The situation in Israel is suddenly its most violent in half a century, while a once-unimaginable war in Ukraine drags on with little sign of resolution.

Relations between the US and China are deteriorating rapidly, almost as if Richard Nixon’s visit to Mao Zedong in 1972 had never happened. The US House of Representatives fired its speaker and then needed three weeks to agree on an ultra-conservative alternative.

And, back on Points of Return’s normal territory, inflation has returned and the interest rates to control it are the highest in a generation.

Now the cold-blooded question is: does this matter? With the very significant exception of 1973’s Yom Kippur War, conflict involving Israel has never moved markets much; and all the horrors in Ukraine have left the S&P 500 index of US stocks almost exactly where it was when Putin’s troops invaded.

“There’s a sense that geopolitics never moves matters because for the last 15 years it hasn’t,” said Tina Fordham of Fordham Global Foresight. “Markets have a short memory. We have so many risk factors present without buffers that I fear they’ve become complacent.”

So far, the response to the undeniably alarming developments in Israel and the Gaza Strip has been muted, with oil gaining and gold rising, but without any “risk-off” move into bonds that might be expected at times like this. Geopolitical concern is, then, co-existing with a shift upwards in long-term interest rates.

Moreover, it’s just possible that the higher rates are in part a consequence of geopolitical developments. On this argument, we are entering a new fragmented era in which interest rates and bond yields will naturally be far higher than before.

Daleep Singh, chief economist of PGIM Fixed Income, who previously served as deputy national security adviser for international economics in the Biden administration, said: “For me, the unipolar moment in global politics is over. That paved the way for the economic Great Moderation. Both the real and the nominal economy will likely adjust in a way that pushes interest rates higher.”

Superpower competition

This can happen through reduced trade and re-shoring, a new need for countries to invest in their own technology, and increased defence spending, all of which will tend to raise interest rates.

Singh said: “Take as a premise that we are living through the greatest period of superpower competition at least since the end of the Cold War; China and Russia both have a desire to challenge the existing order, and there are a lot of G20 countries that are hedging and playing both sides (such as Brazil, India and Turkey among many others). That’s a reason for less global cooperation on salient global risks like pandemics, migration and climate change. As the great powers are also nuclear powers, the global economy is likely to be the field of conflict.”

With the great powers using their economic statecraft, he suggested that there will be fewer flows of trade and technology, meaning slower markets.

Meanwhile, Schroders characterises the shift into a new era as a “3D Reset”, characterised by three big shifts: demographics, decarbonisation, and deglobalisation. The investment needed to decarbonise will also tend to push interest rates higher, as will a Western population with a far higher proportion of the elderly.

As for globalisation, Johanna Kyrklund, Schroders’ group chief investment officer, said that the last two decades had been “all about the invisible hand of Adam Smith gone mad”. But, she said, when Smith came up with his theory in the 18th century, “we didn’t have a global economy, and it turns out that that didn’t benefit the average person in the West, but led to a level of inequality that is unsustainable”. In practical terms, she laid out the changes for investors in the new era as follows:

• The equity-bond correlation isn’t changing any more. You have to own bonds now not for diversification but for yield.
• Valuation matters again, now that the “bird in the hand” (cash) matters again; it’s no longer a fear of missing out, but a “do your homework” market.
• Amid the competition for resources, commodities should have a greater role as diversifiers.

Another consequence of deglobalisation is the return of the nation state. For decades, globalisation meant that the country where a company was headquartered mattered ever less; global sectoral indices tended to be far more useful. Now, with economic and trade sanctions a real risk, that may be over. Individual countries have more control over their own destiny and also, for good or ill, over their investors’ destiny.

Beyond this, Singh of PGIM suggested that superpower competition “feeds the political polarisation that’s pulling us apart from within”, and that “if you have less weight in the political centre, it’s less likely that you get orthodox fiscal policy”. That becomes another reason for higher interest rates. It might even mean that we can draw a line from a fracturing global picture to the extraordinary goings-on in Congress that have at last produced a new Speaker of the House.