Geopolitics back in the game: disruption risks?
Economic activity has shifted to a higher gear this year, fuelling double digit gains on most risk asset classes. However, could resurgent geopolitical threats jeopardize the recovery?
The key risks centre on three regions:
First, in the Middle East, the future leader of Saudi Arabia seems to try to consolidate his power. The situation is moving fast with a number or players involved: Qatar, Iran, Turkey, Lebanon, Syria, Iraq and Saudi Arabia of course… without forgetting Isis, Russia and the US. We don’t expect an escalation, but we do think the risk premium will keep oil prices high for a while. We have upped our target range for a barrel of Brent to 55-61 Dollars.
Second, the US, where both houses of Congress have now released their tax reform proposals and negotiations are ongoing. We believe the odds of an accord have increased; all the more so now that Republicans are under pressure to deliver something ahead of mid-term elections next November. We recommend staying invested in US equities, despite the expense. We can’t, however, state any sector preference as it is too early to fully understand how the final version of the fiscal package might look.
Third, Europe; where some old hurdles have reappeared. While Brexit concerns linger in the UK (with a risk of stagflation looming large on the island), a new front for independence has opened in Catalonia. ETF equity flows are telling us that while European investors are starting to believe in the cyclical recovery in the zone, foreign investors are going to want more clarity on Spanish, Italian and even German politics. In this context, our slight overweight on EMU equity may take some time to bear fruit. French stocks do, however, look set to enjoy the benefit of Macronomic reforms.
All in all, we remain circumspect. So far the balance of risks is contained, but a careful investor should be ready to switch back to short volatility strategies, or gold, and arbitrage the old continent versus new continent politics via the Euro dollar pair.
At the other end of the spectrum, and of the world, political questions have been resolved in China and Japan. Reform agendas are to be pushed forward by President Xi and PM Abe, garnering plenty of international attention and investor impetus. We have turned to slight overweight on Japanese equity but neutralized our stance on off-shore Chinese shares given they have already gained 50% this year.