While the inflation debate continues to dominate financial markets, geopolitical risks do seem to be heating up, says Maarten-Jan Bakkum, senior Emerging Market strategist at NN Investment Partners.
That said, he thinks investors seem to be more focused on the here and now – namely the latest inflation numbers and how the Fed and ECB will behave over the coming months.
“A stronger Western front against China, however, does not appear to present an immediate threat to global trade relations,” he says.
“The outcome of last weekend’s G7 summit confirms that the relationship between China and the Western world has changed dramatically in recent years and that it will remain a source of uncertainty.”
He adds: ” For now, investors do not see imminent risks for global trade and the post-pandemic recovery – and are opting to park the topic for later. We also see limited short-term risks of renewed escalation in the trade conflict.”
Sabre-rattling
Andy Merricks, fund manager with 8AM Global, goes against the consensus view. He is far more concerned with the conflict between China and other nations than he is about inflation risks.
“The tension building between China and Taiwan has been a big fear for some time. The sabre-rattling is a real concern. Taiwan is the major source of semi-conductors (the new oil) globally – and we are close to a flash point here with a huge potential fallout. This is a much bigger threat than whether US inflation is transitory or not.”
Bakkum thinks that, for the short-term at least, major flash points will be avoided. “With the US, Europe and their Asia-Pacific allies building a more united front against China, tensions are likely to ramp up in the coming years, with an increased risk of China responding more assertively to Western criticism about matters it views as domestic.”
He adds: “Once the Chinese authorities think they have reached a critical level of technological self-sufficiency, they are more likely to risk renewed escalation of the continuing trade dispute.”
Corné van Zeijl, analyst and strategist at Actiam believes investors should be worried about China and the West as heightened tensions are never a good environment for stable economic growth.
However, he stresses that these tensions come and go and do tend to be exaggerated.
“If you sold every time investors were afraid of warfare talks of North Korea, they would have missed a significant chunk of their performance.
“The tensions will raise fear of de-globalisation. The more aggressive attitude of China is responsible for a different geo-political attitude. Biden will follow Trump’s line of thinking, although with a normalised tone of voice.”
He adds: “In the longer term it will probably lead to a capex boom in the other regions, as every region wants to build up their own production capacity for crucial industries.”
Inflation impact
We have already heard Merricks’ view that talk of inflation risk has been overdone and he believes growth not value is the place to be. What do other asset managers think?
Corné van Zeijl at Actiam, takes a similar line to Merricks. “The Fed and other central banks think the current inflation boom is transitory. We do think this is the correct view. As long as wages don’t increase faster than underlying inflation.”
He argues that this is not the case yet and he does not think it will be. Labour market figures in the coming months will provide greater direction on this.
Van Zeijl maintains that as long as central banks have this view, interest rates do not need to rise (fast). “In this environment high yield credit can remain at current low spreads and value will have difficulty outperforming growth,” he says.
Daniel Morris, chief market strategist at BNP Paribas Asset Management, believes the recent change in the US Federal Reserve’s messaging about the outlook for inflation and policy rates has certainly altered the outlook for some markets.
“On the one hand little has changed. We still anticipate that rates will be rising and the outlook for equity markets and risk assets is positive. Central bank policy is accommodative, fiscal stimulus is flowing and vaccination rates are improving”.
He adds: “On the other hand, US monetary policy will be tighter sooner than expected. Whereas previously the Fed had emphasised that inflationary pressures were transitory, the bank is now focusing on how strong those pressures are and the need for rate hikes to contain them.
Morris argues that the new Fed priorities mean that some of the ‘reflation’ trades (eg rising Treasury yields and inflation expectations, outperformance of value and cyclical stocks), will need to be rethought.
“Our multi-asset team is currently long US value, emerging markets and Japan. The outperformance of value is dependent both on rising inflation expectations as well as a positive earnings outlook following the collapse in profits during the lockdowns last year.”
Inflation expectations, he argues, will likely be lower now, while higher policy rates will weigh on financial sector earnings, which has a large share in the value indices. Emerging markets, by contrast, will likely do better in the more growth-oriented environment, while cyclicals generally outperform even as policy rates are rising.
Morris concludes: “Both US investment grade and high yield spreads are tight. Given what is still a fundamentally positive backdrop, however, we do not see a catalyst to move spreads materially wider from here. Beyond the strong fundamentals, low default rates lead our credit team to prefer high yield in this environment.”
