Global equities – why markets don't always follow the geopolitical playbook
Our experts explore the interplay between geopolitics and equity markets, underline the importance of diversification and explain how stock market trends don’t always correlate with political and economic headlines.
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Our professional stock pickers constantly consider geopolitics. Some use the associated volatility to generate additional returns. For others the key investment implications revolve around diversification of risk. They all consider what bad, or good news may already be priced in, and remind us how set geopolitical or economic backdrops often don’t correlate directly with equity return opportunities.
Alex Tedder (CIO Equities); Lukas Kamblevicius (Co-Head QEP); and Nick Kirrage (Head of the Global Value Team) recently sat down together to discuss how they’re viewing a particularly uncertain geopolitical backdrop. Five of their key observations are below.
1. Geopolitics is incredibly difficult to forecast
Nick Kirrage: For me, questions about geopolitics always get my brain running exactly the same way, which is, how do I not take a bet here? I think as fund managers, what you've got to appraise when you're thinking about your skillset is not just what do I think I'm good at, but what do I think I might not be good at, and how do I avoid doing that with my client's money? Geopolitics is an incredibly difficult thing to forecast, which is why we focus in on the things we can control and we can know.
Opportunity and threat are usually two sides of the same coin. The question we are constantly asking ourselves is are we baking in an assumption about what a political leader will or won't do when we invest in a certain company or with a certain thesis? Are we making sure we're diversified and we don't have single bets? So, is the outcome to a certain geopolitical situation going to hugely, in a biased way, influence the portfolio? That's what we're trying to avoid.
2. Trends come to an end at some point
Alex Tedder: Our approach is always to look for the companies with the best growth prospects around the world and focus on the fundamentals because this is what we can assess, and that's what we're going to continue to do in today’s turbulent world.
One of the interesting things about this job is the behavioural aspects. People tend to look back and assume that history repeats itself. They tend to extrapolate and don't tend to look forward necessarily. However, things clearly do change, sometimes quite unexpectedly. Looking at the big picture for a moment, in investment terms the US has obviously been dominant over the last 100 years. A beacon of relative stability, the US stock market has been outstandingly rewarding for investors. It has been the American century. Whilst a number of factors, not least the high rate of innovation, continue to favour the US, it is unlikely that this dominance will persist indefinitely. Indeed, current US exceptionalism may well lead to unintended consequences, such as the rise of China as the new global leader.
In the shorter-term, it is interesting to note that European stock markets have already materially outperformed the US this year based on the idea that perhaps expectations have become too negative.
It’s a similar story in China, where we're coming off a very low base. The political environment is still very uncertain, but actually, there are signs of life. That may continue for some time.
Elsewhere, India had been a home run for a long time until the middle of last year. India got to the point where valuations were extremely extended, expectations were very high, and investors have cottoned onto that and started to think, well, maybe a pause is due. The fundamentals for India remain great, it's just the price you're paying for them is extremely elevated. Therefore, the correction or the adjustment in the market is already happening and probably will sustain. The opposite is true in China.
3. Separate out politics, economics, stock markets and the stock picking
Nick Kirrage: I think it boils down to what's discounted, where are expectations. The long-term demographics and political backdrop and a lot of the things that we would say are structural are well set, and quite well understood. Some of them will change over time. But the question is, what are you paying for them?
The other thing is that even in markets that are well set, there are businesses that are more challenged, and vice versa. You must be very careful. I think a lot of investors get sucked in when it comes to emerging markets because of the very high levels of GDP growth over time. That is attractive and they can be very dynamic economies. But on average, something investors forget is there is simply no correlation between a country's GDP growth and its stock market growth.
4. Disruption, volatility and opportunities for quantitative strategies
Lukas Kamblevicius: We've definitely seen elements of a heightened volatility environment so far this year. I would say the only certainty is that uncertainty is here to persist.
I think for us as active managers, looking at the client portfolios on a daily basis, risk management is going to be key. I think the discipline around profit-taking and recycling those proceeds to the areas that potentially have been less affected or weathering the storm a bit better is going to be key. If anything, the last couple of years have been quite trend-driven markets, which were easier to navigate without volatility dominating.
I think this year is going to be the opposite to what we have seen over the last couple of years. There's going to be disruptions and volatility will present opportunities, and it will be up to active managers to capture them.
For more on how enhanced index managers can combine quantitative analysis with fundamental insights to navigate the disruption and volatility of equity markets read here
5. Investors with long-time horizons have a better opportunity
Alex Tedder: Investors have to take a long-term view. If you're investing in equities, you're not investing for tomorrow, you're investing for five, 10, 15 years. If you're young, you've got to take that perspective and be prepared to look through short-term volatility.
Cost is certainly a factor and investing in products that have low expense ratios, such as passive funds, is definitely helpful. However, investing with managers that have a commitment to active investment, to adding value to passive benchmarks, can be incredibly rewarding over time. Even compounding at a 1% or 2% rate over a benchmark can really make a tremendous difference over time. My view therefore is you should have both passive and active components to your investments. You might invest passively, but you should also think very carefully about what matters to you in the long-term and where do you see structural opportunities that won’t be adequately reflected in a passive portfolio.
Then look for active managers that are aligned with your thinking and which have a philosophy and investment process that makes sense.
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