Article written by Scott Haslem. Published in The Australian Financial Review February 12, 2024.
Elections all over the world mean this is the year when even a constructive backdrop for markets is likely to be challenged by geopolitical changes.
More than half of humanity is heading to a ballot box in 2024, the most in human history. There are more than 60 “national” elections across the world in the year ahead.
An expected Biden-Trump 2020 re-match in November will likely be the focus for many. But there are also elections in India – the most populous nation in the world – as well as in Russia, the UK, Indonesia and the European parliament.
Some will rightly argue such events rarely affect financial markets in a sustained way. Elections, wars, trade wars and other geopolitical disturbances come and go, and markets trend higher and assets pay income.
Indeed, the unfolding backdrop for markets is looking increasingly constructive this year. Growth is slowing (not collapsing), inflation is trending lower while central banks are positioning for mid-year cuts.
But 2024 is also shaping up as one of those years when this macro backdrop could still be challenged by politics which reach beyond domestic arenas and drive geopolitical volatility.
This will add to the volatility and dispersion we are already seeing, with the ups and downs in bond markets pushing volatility to its highest in 40 years, equal only to the global financial crisis. Equities are also seeing significant dispersion of returns, with some sectors in the US reporting season winning big (technology) and others struggling (healthcare and energy).
In 2024, with Donald Trump outpolling Joe Biden in surveys, markets are likely soon to turn their attention to pricing the potential impact of a more “isolationist” or “America first” regime emerging in 2025.
Could the US scuttle Ukraine’s efforts by removing its support? How committed is the US to defend Taiwan against a China incursion? Similarly, will the US continue to apply diplomatic pressure to calm Israel’s actions in the Middle East, minimising the risk of escalation across borders?
Will the US continue to muster forces to repel militants in the Red Sea – one of the world’s busiest shipping lanes – to minimise the inflationary impact of ships having to take the longer route around Africa? Closer to home, the South China Sea is a key shipping route vulnerable to disruption as well.
Disruption may confront the global growth outlook should Trump introduce his mooted 10 per cent tariff on all imports. This would likely face global retaliatory actions. Using that revenue to fund tax cuts could also raise further concerns about the sustainability of US government spending, limiting how low US bond yields will settle, a key valuation metric for risk.
In India, Prime Minister Narendra Modi appears on track to secure a third term, helped by policies supporting lower income households. Some are arguing the “price” is increased centralisation of power, a threat to democracy. More positively, the focus on boosting digitalisation and manufacturing is likely to help India remain one of the fastest growing economies globally, securing a greater share of investment capital within emerging markets, including flows otherwise destined for China.
What does all this mean? As markets battle to understand the implications of shifting politics and geopolitics, it suggests volatility and dispersion will be investors’ constant companion through 2024 and 2025. Many of the geopolitical implications have an inflationary angle, supporting LGT Crestone’s long-held view that inflation is unlikely to settle as low as it trended pre-pandemic.
These risks could also support the economic dominance of the US, and challenge consensus for a broadening out of a global recovery through 2025. Similarly, the US dollar – historically, a beneficiary when the world looks wobbly – might stay expensive for longer, challenging consensus for the Aussie dollar to rise to US74¢ by the end of 2025.
Thankfully, one of the keys to delivering long-term risk-adjusted returns – diversification – is likely to be the best defence against this politically led uncertainty, potential volatility and dispersion of returns.
Key for portfolios will be ensuring local and offshore allocations across both equities and fixed income and, where accessible, unlisted alternatives. Alternatives also provide opportunities to minimise monthly volatility and build inflation protection into returns.
Volatility is also driving many sophisticated investors to limit the size of their tactical “bets” across assets, instead letting well diversified portfolios be their defence. Focus has turned to taking more selective tactical opportunities in sub-asset classes when value emerges.
Finally, many investors have been discovering the long-lost benefit of higher-yielding fixed income or bond-like assets in recent years as interest rates have risen. The mistake may be jettisoning these investments too soon on the basis that rates will adjust lower. With inflation likely to be higher than it was pre-pandemic and the potential for politics to unsettle the outlook, these fixed income investments could provide a much-needed defensive ballast to portfolios ahead.