Looking at what has changed for long-term investors during the last decade paints a sobering picture. In October 2014 macroeconomic factors were at the forefront of investor concerns. The International Monetary Fund had forecast global gross domestic product growth at 3.3%, after an outturn of 3.3% in 2013.
In 2014, the key discussion for investors revolved around the decline in US Treasury yields (the 5-year note yield was around 1.5%). For central bank reserve managers this led to a discussion on how best to diversify into higher-yielding fixed income such as investment-grade credit, into public equities and into new currencies such as the renminbi.
By contrast the primary discussion at conferences this year has been the geopolitical situation, or what historians have labelled the second cold war. The change in the political temperature has triggered military action, political pacts, economic nationalism, sanctions and tariffs. Adam Smith’s policy objective of maximising the wealth of nations is being swapped for one that maximises the security of nations. Increasingly rival nations prefer to avoid the risks and forgo the benefits of free trade.
Trade patterns have changed. China has tightened its rules on imported food to encourage domestic production and achieve food security, while the Joe Biden administration is offering incentives to Taiwan to manufacture chips in the US. Profit maximisation and efficient use of capital are no longer the paramount drivers of economic investment.
In 2014 we did not appreciate just how pivotal the year would be for geopolitics. In a cynical move just a few days after the closing ceremony of the Sochi winter Olympics, Vladimir Putin began his grab for Crimea. Annexation followed in March. Surprisingly, the IMF world economic outlook in October did not directly address Putin’s annexation of Crimea – only to acknowledge heightened tensions between Russia and Ukraine. Sanctions regimes were slowly mobilised after Crimea was annexed, and the election of Donald Trump in 2016 facilitated a snowball effect of tariffs and counter tariffs (Figure 1).
Figure 1. Trade restrictions have increased sharply
Number of interventions
Source: Global Trade Alert. Note: * extrapolated from September 2024 data
Geopolitical surprises
The biggest drivers of financial markets in the last decade have been the unexpected things that have overwhelmed our carefully considered medium-term quarterly economic forecasts. The most significant was the Covid-19 pandemic, a global health crisis that was predicted by nobody.
Pandemic fiscal policy responses in 2020 were massive and created multiple economic distortions that have not been unwound. We now have public deficit and debt numbers that were previously unimaginable. Governments have shown an unwillingness to grasp that nettle. But will markets eventually force them to do so?
Putin’s invasion of Ukraine in 2022 led to sanctions, disrupted supply lines and rapid increases in the price of gas and oil. This boosted inflation rates that were already moving higher. Most nations saw a 40-year high headline consumer price index print. The war also dislocated and reshaped trade flows in unimaginable ways. Russian oil was banned from the European Union, but welcome in India, which now takes most of the oil that used to be exported to the EU. India pays for a lot of it in Abu Dhabi dirhams.
Third, Trump did not feature highly on the list of likely presidential US candidates in 2014. Yet, in a world of frosty relations with China, Trump was a willing actor when it came to taking the trade war to China and agreeing a policy of tariffs and sanctions. The portents are for more of the same in 2025 if he wins the election in November.
Next on the list of surprises is President Xi Jinping of China engineering a job for life in 2018. Securing his domestic political situation might have encouraged Xi’s appetite for foreign policy adventure. The rollout of the Belt and Road Initiative began in 2013 and was announced as a trade policy. Over the last decade it has taken on the appearance of an increasingly strategic geopolitical project. Trade and military alliances go together.
The crisis in the Middle East will not have surprised many, but the Hamas incursion into Israel in late 2023 surprised everyone. That is the trigger for the current extreme tension between Israel and Iran.
The axis of ill-will is a phrase used by the historian Niall Ferguson to describe the alliance between Russia, China, Iran and North Korea. Evidence of their increased co-operation and deepening relationship is evident in the exploded material on the battlefields of Ukraine. In which military theatres of operation might this axis operate next? Will a confrontation with Nato be inevitable?
Finally, don’t overlook the UK’s departure from the EU – a local story but one that opened the sores of populist and nationalist sentiment that have been bubbling in the UK for many years.
Looking to the future
The economic nationalism that ties all these events together has consequences. ‘Just in case’ replacing ‘just in time’ in global supply chains has implications for trade patterns and the prices of goods. It will often mean paying higher prices to ensure more security of supply (i.e. a higher floor for CPI in future cycles).
For foreign exchange reserve managers, it may also have implications for constructing portfolios, such as building your friends into the asset allocation for what is effectively a national wealth portfolio and perhaps having to choose which political bloc you want to belong to.
What about the next 10 years? Events that might today be impossible to imagine will once again jolt financial market volatility when they occur.
We can’t forecast unknown unknowns, but we can highlight known unknowns. In 10 years from now Iran’s supreme leader Ali Khamenei will be 95, Putin will be 81 and Xi will be 82. Although North Korean President Kim Jong Un will be 50, his health status is not clear. We predict that regime change in any (or all) of these countries is coming, but we don’t know what it will look like. Succession planning is not transparent. This will be difficult for financial markets to price accurately and suggests that we will continue to see bouts of amplified volatility.
When will the rubber band on fiscal policy – stretched like never before in 80 years – finally break? Led by the US – fiscal laxness argues for a higher floor for long rates in the longer-dated future (i.e. at the end of the current Federal Reserve-inspired bond yield cycle). Will bond investors refuse to buy? Or will a first mover on fiscal consolidation enjoy a market response that eventually forces others to follow?
Economic nationalism looks as though it is baked in. As we saw in the 1930s, tariffs and sanctions tend to lead to tit-for-tat responses, and a vicious spiral. It is very difficult to see how this problem can be defused. It will be an important theme for the next 10 years. The question is how best to incorporate the theme into investment strategies.
We are in a much more complicated world than in 2014. The argument is for a nimble approach to portfolio management. Periods of heightened market volatility will create an environment where active management should beat passive. Investors should make their investible universes as wide as possible, use as many investment tools as guidelines allow and work with investment managers that have a strong track record.
Gary Smith is a Client Portfolio Manager at Columbia Threadneedle.
