The geopolitical rule book is being rewritten, so what does it mean for global asset allocation? asks Anthony Rayner Fund Manager, Premier Miton Macro Thematic Multi Asset Team.
The rules for the global economic and political system are being rewritten. First by the new US administration and then, as a result of the US dominance globally, they are also being rewritten elsewhere. The rule changes reflect many things but central is the decline of the US empire and their desire to retain their powerful position.
Much of the commentary focuses on the personalities involved and the headline noise but much of the substance of the underlying actions are typical of the way leaders of an empire in decline behave. In brief, they become more obviously self-serving or, indeed, more desperate.
Importantly, when the rules of a complex organic system, such as the global economy, are rewritten it is very difficult to anticipate what the implications of the changes will be. That said, we can make some observations which will provide a broad framework for assessing the environment for financial markets.
Stepping back, recent events are consistent with our base case that we are moving from a unipolar to multipolar world, as the distribution of global power becomes less concentrated in the US. This feeds our higher for longer base case, with increased conflict and deglobalisation at the core. Our view has been that increased economic and military tensions will stimulate government spending, as politicians try to mitigate the impact of these dynamics, thereby pushing yields higher.
A fine example can be seen in the recent behaviour of the German bond yield. The background is that, as the US threatens to withdraw from certain areas militarily, so it puts pressure on others to fill the gap. In this case, European governments felt forced to increase their defence spending. Specifically, Germany, who has been historically fiscally disciplined, pushed for an exemption to the EU’s fiscal rules to allow more defence spending.
The financial market response was that the daily rise in the 10 year German bond yield was the biggest since German reunification in 1990. This reflects, we believe, a once in a generation shift in the fiscal regime, due to the transatlantic alliance coming under threat.
Higher yields, through higher cost of capital, add to a more demanding environment generally. One where democracies are already struggling to meet their side of the social contract. This is in part as fiscal dynamics come under more pressure, with debt piles elevated in a historical context and economic growth pretty scarce. As a result, governments are less able to prioritise electorates struggling from the higher cost of living and increased inequality.
So what does this all mean for financial markets and asset global allocation? A more demanding environment will likely lead to investors being more discerning and, specifically, will lead to more dispersion between the strong and the weak, at a company and country level. This means increased risk but also increased opportunities, not just for identifying those areas that will benefit but also diversification potential.
This will be a positive time for genuinely active global multi asset managers, as they look to pull their many levers in the most appropriate way. It will be especially positive for those that have an open mind.
For example, many UK investors will always assume that UK government bonds are the go to risk-free asset. Certainly, gilts don’t hold any currency risk but in 2022 the 10-year lost almost a quarter of its value. More generally, many fund managers will assume that government bonds generally are a great way of diversifying equities. Indeed, they are great in periods of low inflation but not in periods of higher inflation, where they become much more correlated with equities, as we have seen more recently (see chart below on US equities vs US Treasuries).
Source: Bloomberg data from 31.12.1974 to 31.12.2024. Past performance is not a reliable indicator of future returns.
Similarly, many investors don’t consider commodities as part of their investment universe, especially those that have done well out of the growth dominated equity-bond 60/40 model of the last few decades. However, when inflation is elevated, commodities are much better diversifiers of equity than bonds (see chart).
Environments change. That might sound obvious but behaviours are often slow to react, especially when habits have been forged over decades where the broad environment has remained largely unchanged.
We are in a new world where the behaviour of many asset classes relative to their history and relative to other asset classes are likely to change. As a result, investment assumptions need to adapt too.
Past performance is not a reliable guide to future returns. You may not get back the amount originally invested, and tax rules can change over time. The writer’s views are their own and do not constitute financial advice.
This information should not be relied upon by retail clients or investment professionals. Reference to any particular investment does not constitute a recommendation to buy or sell the investment.
Main image: gael-gaborel-orbisterrae-f7I8uEiYkag-unsplash
