Embracing Disruption
Summer storms and political winds – what current market volatility tells us about shifts in the global order
Recent days have seen significant market turbulence, with sharp corrections on both sides of the Atlantic, as well as in Asia Pacific. While the immediate causes of investor angst are clear and have been widely reported on, these come amid more profound changes to the global economy and patterns of trade, as well as a changing geopolitical order.
A summer storm
The US Federal Reserve’s recent indication that rate cuts will be coming soon – on the surface, a promising signal for equity markets – led to immediate concerns that the world’s largest economy was possibly beginning to falter, concerns amplified by recent payroll and jobs data that showed the labour market cooling significantly. Indeed, the so-called “Sahm Rule” – an indicator that uses monthly unemployment data to predict recessions – has historically been very robust in foreseeing downturns in the business cycle. However, the big danger here is reacting to a single data point; the US economy has recently shown remarkable resilience, and it seems unlikely that a recession is imminent.
As markets digested the payroll and jobs data, while assessing the Fed’s intentions, a rate hike in Japan added to market woes as the prospect of yen “carry trades” – where cheap financing is sought in jurisdictions with low interest rates – unravelling further spooked markets across the globe. In addition, after an extended period of impressive results, buoyed at least in part by hype around the rapidly growing artificial intelligence segment, the sheen is starting to come off some tech stocks. And this view has been fueled by recent events, including a high-profile failure in the cybersecurity sector and some manufacturing delays from leading chip makers.
These economic factors come alongside the potential for worrying escalation in the Middle East as Iran-Israel tensions continue to rise. Yet while the proximate causes of recent market turbulence are clear and some short-term losses will be recovered in the coming days and weeks, investors should be mindful of more profound shifts in the global order. Some of these are underway and the consequences can already be identified, while others will depend on how the currently highly unpredictable global political landscape changes in the coming months and years.
Changing political winds
The biggest known unknown on the horizon is the outcome of the US presidential election later this year, and recent events – the attempted assassination of Trump, and Biden’s withdrawal and replacement by Harris – have changed the nature of the electoral race. While a Harris victory would likely represent a degree of continuation with the policies of the Biden administration, the prospect of a Trump victory introduces a much more unknown quantity.
Indeed, a second Trump administration is likely to look very different from the first. In economic terms, Trump 1.0 was characterized by deregulation, rate cuts, and increased fiscal spending. However, we are now at a very different point in the economic cycle to where we found ourselves in 2016. Then, GDP and earnings growth figures were in a period of upward revision; now, any significant economic expansion would likely mean higher inflation. Furthermore, debt held by the US public has grown significantly over the same period, at a time when central bank balance sheets are shrinking and OECD savings rates are falling sharply.
Despite the uncertainty, one area where Trump has been vocal has been trade and tariffs. A discussed 60% tariff on Chinese goods – in addition to a 10% universal tariff – would affect over USD 3 trillion worth of imports, around 10 times more than those affected in Trump’s first term. This would certainly have an impact on inflation – one source estimates the cost to be around USD 1,700 per household – but it would also have further impacts, on import substitution for example, that are more difficult to predict and quantify. And this is in addition to the potential impact of retaliatory tariffs levied by China.
Outside of the US, the global geopolitical situation is changing significantly. Conflicts in Europe and the Middle East add a high degree of unpredictability to the global scene, while China’s growing influence and assertiveness on the global economic and political stage continues unabated, despite the country dealing with its own domestic issues around reconfiguring its economy aways from property towards innovation-led growth.
Changing outlook
While many of the losses incurred during the recent dip will likely be recovered as current market hysteria abates, investors should not lose sight of the profound changes both the global economy and the geopolitical landscape are undergoing. The roles of China and the US, in particular, in the global economy are shifting significantly and investors should play close attention to the implications of this changing paradigm over the coming months and years.
In terms of our outlook, little has changed – some level of volatility in equities is to be expected between now and November, but the medium- to long-term outlook is positive and promising entry points to markets remain.
