For information purposes only. The views and opinions expressed here are those of the author at the time of writing and can change; they may not represent the views of Premier Miton and should not be taken as statements of fact, nor should they be relied upon for making investment decisions.
The front of mind risks that markets fixate on often overshadow background risks, but not necessarily because the background risks have a lower probability risk and/or a lower impact risk. Front of mind risks tend to be easier to understand and more talked about and therefore rise up the risk list. On the other hand, background risks tend to be more complex and potentially slower moving, and therefore less eye-catching, thereby falling down the list.
Currently, and in fact for the last few years, markets have been fixating on rates and inflation, to the extent that most other risks are obscured. Inflation risk is fully embraced by the market, whether you fall into the lower for longer, or higher for longer camp. It’s a fairly simple economic concept to grasp and one that we all see in our daily lives. From an investor perspective, there are frequent data points to focus the mind: consumer prices, core prices, producer prices, services, inflation expectations, central bank comments, central bank rate decisions, etc. Lots of data which makes lots of noise and keeps it front of mind, overshadowing many other risks.
On the other hand, geopolitical risk, for example, is much more complex, generally slower moving and with few data points, relegating it further down the risk list. That said, the dynamics of how power is shifting globally is very clear. The Greek historian Thucydides wrote, “It was the rise of Athens and the fear that this instilled in Sparta that made war inevitable”. The so called “Thucydides trap” suggests that the decline of a dominant power and the rise of a competing power make war very likely. Turning to today, it’s not to say that war is inevitable between the US and China, but we should expect tensions to escalate and also not to be limited to China and the US, as respective allies get drawn in.
Looking back over the last century, there has been an extended period of relative peace since the end of the second world war. More recently, however, the conflicts in the Ukraine and Gaza have been more significant and more extended than most initially thought they would be, indeed fatalities in ongoing wars are now at a 50 year high.
We believe that geopolitical risk is very important, even if markets tend to ignore it or pay attention to it in very short bursts. History shows us that major conflicts are inflationary, as governments tend to print money to fund war efforts, look at the first world and second world wars as examples.
Similarly, we don’t think it’s a coincidence that the low inflationary period from 1990 to 2020 was also a period of relative global peace. However, as tensions build between the two superpowers, with their economic and military power converging, the dynamics are changing. More recently, two major pieces of US fiscal policy have been the so-called Inflation Reduction Act and the CHIPS act, which are both attempts to ring-fence two strategic industries from the Chinese. These two acts account for around US$400 billion of tax credits, loans and grants, which is of course inflationary. More directly, there is also pressure to increase defence spending, which conflicts with already historically high government debt levels.
Elevated conflict tends to lead to reduced global trade, as countries close their borders and try to protect their economies. Again, we don’t think it was a coincidence that the 1990 to 2020 period was not only a period of relative peace but also an extended period of globalisation. More recently, global tensions have risen and we are experiencing de-globalisation, which is adding to inflationary risk. This can be seen through tariffs and trade barriers, or more physically, through Suez canal traffic which has collapsed due to tensions related to the Israeli/Palestine conflict.
Suez canal traffic has collapsed
Source: Bloomberg 14.03.23 to 13.03.24.
Ironically, markets are focusing their attention on inflation prints and less so on some of the longer term forces feeding inflation, such as increasing conflict and deglobalisation. We retain our view that inflation will be higher for longer and therefore uncomfortable for central banks. We have a material exposure to risk assets, including inflation beneficiaries, such as gold, oil, agricultural commodities and property. We also retain a short duration exposure in bonds, to limit interest rates risk.
