Multi-polar world could present opportunities

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Escalating volatility and geopolitical tension is putting pressure on returns, but the Newton Real Return1 team thinks this could also create opportunities in certain areas.

With the US, China and Russia heading for a prolonged period of geopolitical tension, the Newton Real Return team thinks we are in a “multi-polar” world. As well as accelerating deglobalisation, this dynamic is likely to lead to higher volatility and jeopardise returns from risk assets, but it could also create opportunities for stock picking investors, it believes.

The Real Return team says the years of falling inflation and low interest rates acting as a powerful tailwind to asset prices are likely to have come to an end. With the return of inflation, it expects equity returns to be lower after central banks lost their flexibility to elongate the business cycle through lowering rates.

“The starting point today is lot less favourable than it was at the start of the ‘Great Moderation’ in the mid-1980s, after the global financial crisis in 2009, or in the aftermath of the Covid-19 pandemic in 2020,” it says. “Profit margins are elevated, valuations are stretched, and policymakers have no choice but to increase policy rates to fight inflation. We are therefore likely to reset into an environment with lower equity market returns, higher volatility, and shorter boom/bust cycles.”

A multi-polar world

The team says we are now in a “multi-polar” world characterised by the intense and drawn-out military conflict in Ukraine and geopolitical tensions in the Asia-Pacific region. The latter were stoked in August after US House of Representatives speaker Nancy Pelosi visited Taiwan, becoming the first prominent US politician to visit the country in 25 years2.

The Real Return team thinks the world is shifting from ‘efficiency economics’ to ‘resilience economics’, as western economies look to boost investments in strategic areas such as food, energy and defence, while placing lower priority on cost and achieving maximum efficiency. “The trend began with former US President Donald Trump’s ‘America First’ policies and has been accelerated by the Covid-19 pandemic and most recently the war in Ukraine,” the team adds.

It thinks multinational companies that have embraced globalisation could see a significant impact on their supply chains, capital-expenditure requirements and profit margins. ‘Old economy’ style businesses in many industries require a steep uptick in capital expenditure after years of chronic under investment, while the green energy transition is also likely to require additional spending.

The Real Return team says: “Over the last 15 years, cheap money has flooded into areas such as technology, but few were interested in capital expenditure-intensive businesses and commodity producers. Supply-chain bottlenecks and supply-demand imbalances are likely to prompt a change.”

It adds: “Higher corporate capital expenditure, together with increased government spending and fiscal stimulus, has the potential to bring higher growth, higher inflation and higher interest rates across the curve.”

Buying the dip?

The team questions whether this shift is likely to “spoil the party for risk assets”. It adds: “This seems highly probable, with expected returns set to be lower after an already challenging period.”

The team notes over the last four decades “everything went up pretty much all the time”, and if there was a dip it was viewed as a buying opportunity. However, that approach may not work this time, it adds, meaning this environment could present opportunities for active investors: in equities, stock selection is likely to be important, while flexible multi-asset approaches could also be relevant.

Assets such as shorter-dated government bonds and gold may do well in this environment – the former as a ‘buy and hold’ strategy, while the latter is a real asset alternative to fiat currencies and cannot easily be manipulated,” the team adds. “Elsewhere, gold has the potential to serve as a buffer against geopolitical risks and fiat money debasement, which are front and centre of investorsminds given the current backdrop.

In summary, despite the environment being challenging, it is not devoid of opportunities for active managers,” the team concludes.

1 The value of investments can fall. Investors may not get back the amount invested.

2 Guardian. Pelosi’s ‘reckless’ Taiwan visit deepens US-China rupture – why did she go? 7 August 2022

1145812 Exp: 17 April 2023

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