This is odd, as one might’ve expected 2018’s market rout to have sowed the seeds of dissent towards years of market bullishness. On the contrary, the sell-off merely created “more attractive valuations” (HSBC), and the need for “prudent portfolio positioning” (Lombardier), underpinned by “continued expansion in global growth and corporate profits” (Goldman Sachs Asset Management) and continued support from the US Federal Reserve (BlackRock).
Other uncontroversial takes include a preference for US equities, while the “overweight technology” thesis is a mainstay, largely because it has worked so far (since both the financial crisis and the dawn of human civilization). In short, it’s a nod from the investment industry to keep the faith.
Within this groupthink, another constant is talk of "geopolitical risk". Often, it arrives as shorthand for the unknowable and unpredictable nature of our complex political world, or a synonym for market risk. Elsewhere, it stands for a specific shift in global power, which State Street head of policy and research Elliot Hentov characterises as international organizations, treaties and laws ceding influence “to the unilateral actions of major countries, based on raw political power”.
“The lack of transparency around these unilateral decisions by executive administrations is likely to lead to regular market surprises,” Mr Hentov adds.
In other words, the largest names in finance have a less clear idea of the direction and agenda of global politics and how markets will respond, but still cling to the idea that equities are a good place to put your money. It begs the question: what do any of the predictions mean for markets and financial assets if geopolitical risk coalesces into geopolitical crisis?
Fortunately, some have tried to quantify these risks for investors. Last week, Deutsche Bank’s macro research team released a report which asked how far economic growth could fall if there were an intensification in global risk – or “crosscurrents” as Federal Reserve chairman Jerome Powell recently dubbed them. It gives the impression that any short-term optimism could be misplaced.
For the report, the analysts sought to calculate the possible five-year impact of three risks at the top of the geopolitical agenda: a significant escalation in trade tensions, a no-deal Brexit, and a sharp slowdown in China’s growth. Deutsche ascribes a 5 to 10 per cent probability that “fairly extreme tail-risk versions” of each of these risks arise at some point in the months ahead, which amounts to a greater threat to markets than major investment banks currently envision.
In fact, the bank found that an escalation in trade tensions could “hit financial markets hard enough to yield a mild recession in the US”, which would be enough to depress global growth by more than a percentage point over the next two years.
A Chinese slump would be “at least as” bad, and could be transmitted through an indicator no-one is talking about: food. The threat from China is broadly thought of in terms of the country’s extreme leverage, and how the People’s Republic adjusts to slower, consumer-led growth. In the context of this “accident waiting to happen”, Deutsche envisions a possible shock to Chinese inflation from a sudden rise in food prices, and suggests that the subsequent monetary tightening and deleveraging this could force would be “severe enough to cause a substantial slump in China's growth”.
Finally, there is a hard Brexit, whose elevation into the top three geopolitical risks could be viewed as an overly eurocentric take on markets (though given their company’s fragility, Deutsche analysts will have a keener appreciation of this than many of their peers on Wall Street). But in the event of a no-deal, the report suggests that a two-year major contraction in the UK could induce recession in Europe, and provide a tipping point for the already “serious possibility” of an Italian debt crisis. In short, the risk is just as serious as China or trade wars.
