Source: Bloomberg, CPB
In terms of financial risks, the key word is unconventional. The last decade has witnessed unconventional monetary policies. How resilient will economies and markets be as central banks opt to reverse their unconventional policies? Ideally, central bank policies should be gradual and predictable, as they normalise policy.
It is, however, the valuation of markets that is one of the major issues, and whether, as was not the case a decade ago, markets are pricing sufficiently for risk. For instance, the combination of high debt levels and higher rates, depending on the market one is looking at, adds to a renewed focus on credit risks.
When it comes to geopolitical risks, the key word is friction. There is increased friction in a host of areas, for example, in the trade issues between the US and China. Numerous geopolitical issues come to the fore from time to time, as we have seen in recent weeks.
Yet when one looks at the VIX index (the most common benchmark of market volatility), or the oil price (where in times of crisis a risk premium is often factored in), it is not clear that markets are pricing in geopolitical risks to any great extent. Often, that is because it is a case of small probability, high impact events. That is, there is often a lot of noise about geopolitical issues, but often these do not escalate. But when they do, it can have a big impact, particularly if, say, oil prices are forced higher.
The big geopolitical worry is trade, and whether it dampens global growth in coming months, and also whether it spills over into the wider relationship between China and the US. Thankfully, Presidents Trump and Xi are due to meet twice this autumn, and the expectation is that this will allow a potential defusing of current tensions, and certainly not an escalation of them.
These issues, naturally, figure in our investment thinking. In the face of increased risks, for instance, are there safe havens? One of our ongoing themes is that it is “time in the markets”, not “timing the markets” that is key. It is hard to identify turning points exactly but getting the balance correct between macro-economic indicators and market valuations is important.
Some assets may appear safer than others – for instance, the yen may be a good counter-cyclical allocation offering protection in some portfolios. There are others. But overall, the key is to not lose sight of what is happening now (such as a strong US economy), or of the positive longer-term global fundamentals, but also to ensure we take into account the need to price properly for risk. Here we have highlighted three key words reflecting this: sustainability, unconventional and friction.
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