Gauging deglobalization: How to identify geopolitical disconnects

Esta semana presentamos a Eric Van Nostrand, jefe de Análisis Macroeconómico y Estrategia de Carteras para el Grupo de Estrategias de Activos Múltiples de BlackRock

Los mercados están dando señales contradictorias. Después de una recesión a finales de 2018, hemos visto al mercado de acciones recuperarse en 2019 frente a un trasfondo de altibajos geopolíticos. El golpe parece tener probabilidades de continuar, con disputas comerciales que siguen su curso en casi todas las regiones del mundo, elecciones de 2020 en EE.UU. a toda marcha y aumento de las tensiones en el Golfo.

Nuestra medición del nivel de conversación del mercado relacionada con la geopolítica, el Indicador de riesgo geopolítico de BlackRock, se encuentra en su nivel máximo desde 2005. En este episodio de The BID, hablamos con Eric Van Nostrand, jefe de Análisis Macroeconómico y Estrategia de Carteras para el Grupo de Estrategias de Activos Múltiples de BlackRock, para preguntarle cuáles son los motivos de la situación actual y cómo incorporar la geopolítica en el proceso de inversión.

Nota: Todos los episodios se graban en inglés

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  • Catherine Kress: Markets are sending pretty mixed signals. At the end of 2018, we saw a downturn, yet in the first half of 2019, we've seen the stock market rally against a backdrop of incredible volatility in the international environment.

    This geopolitical whiplash looks set to continue with the 2020 elections in the U.S. in full swing, a Brexit deadline postponed to October, trade disputes ongoing in almost every world region, and tensions building in the Persian Gulf. This wide range of unstable situations leads us to believe that trade tensions and broader geopolitical concerns will be a key driver of the macro and market environment moving forward.

    On this episode of the The BID, we'll be speaking with Eric Van Nostrand, head of Macro Research and Portfolio Strategy in BlackRock's Multi-Asset Strategies Group. Eric is one of the smartest people I've met when it comes to teasing out what big picture issues like geopolitics mean for markets and investing. He's pioneered a variety of approaches for helping to identify the disconnects between macro developments and market movements and seizing on the opportunities that those disconnects create. From the BlackRock Investment Institute, I'm your host, Catherine Kress. We hope you enjoy.

    Eric, thanks very much for joining us today.

    Eric Van Nostrand: Thank so much Catherine, great to be with you.

    Catherine Kress: Let's start off big picture. There's been a lot going on on the geopolitical front. What's top of mind for you right now?

    Eric Van Nostrand: Catherine, the last six months have seen the evolution of a lot of different geopolitical issues that have been festering for a couple years but have really come to the forefront in the past two months. Chief among them is China and its trade relationship with the U.S. The breakdown of the negotiations at the start of May in Washington have, in our view, fundamentally changed the relationship between the U.S. and China in a way that's going to make it more strategically competitive and more economically competitive in the years to come. And that matters a lot for financial markets. At the same time that these U.S. and Chinese tensions are rising, we're seeing persistent geopolitical risk in the Gulf and continued uncertainty coming out of London as the Brexit negotiations continue. All these risks together, coming from different angles, but each mattering a lot for financial markets in their own way, are going to be very important for investors to watch in the near term.

    Catherine Kress: Right and we've specifically highlighted that geopolitical risks can matter more for markets when the economic backdrop is weak, so these will all be pretty important issues to watch I think moving forward.

    Eric Van Nostrand: That's exactly right, slowing global growth makes this all much more important than it otherwise would be. I think it's clear that geopolitics has mattered a lot more to financial markets in the past few years than it it did in the past few decades. But more specifically, geopolitics has mattered a lot more just in the past couple weeks. I think the biggest difference is that in the first week of May, the U.S.'s relationship with China changed meaningfully in a way that is unlikely to improve pretty meaningfully in the near term. That's something that matters a lot to markets in the months to come. BlackRock's own indicators of geopolitical risk, for example, have shown a much higher correlation with overall financial asset moves – with what stocks and bonds have done in the past couple weeks – even more so than they have over other periods of the Trump era where geopolitics has mattered a lot. So it's going to be incomplete to have a financial market conversation in 2019 without really engaging thoughtfully on the geopolitics.

    Catherine Kress: When you say correlations, you mean that geopolitics and markets are moving much closer together, implying some kind of a closer relationship than perhaps we would have seen previously?

    Eric Van Nostrand: That's exactly right. The markets are following the geopolitics. What's happening out there in the world matters a lot for U.S. investors.

    Catherine Kress: We both just highlighted U.S., China. What are some of the key issues or flashpoints that we should be thinking about?

    Eric Van Nostrand: So I think in general, we should take a step back and recognize the following, which is that it's very easy to talk about the various geopolitical issues of the day and say that they might matter for financial markets in general, but unlike most of the things that investors at BlackRock track to forecast financial market moves, geopolitics is very hard to measure. So the particular flashpoints we're going to be looking for are those that really bring into focus geopolitical risks and geopolitical concerns that right now appear to be in the background. There are really two types of flashpoints I think we're going to be watching from a geopolitical perspective as we think about asset allocation and investing in the firm: (i) those that involve short-term tactical positioning – thinking about how the Brexit parliamentary negotiations are going to shake out over the coming weeks; or (ii) more strategic themes, such as how broader trends of deglobalization and the economy are going to evolve over the years to come. Deglobalization in particular is probably the single most important thing for financial market participants who are concerned about geopolitics to be following. Because what that reflects is the reversal of a trend that has really characterized the evolution of the global economy over the past couple decades and that we've become quite used to as a source of ongoing stock and bond market returns. Every piece of trade news that comes out of the Trump administration's negotiation with China, every bit of information about when auto tariffs with Europe might start to materialize, is going to be important for figuring out the extent of that trend and what it matters for the economy.

    Catherine Kress: One thing that I noted was particularly interesting in your comments is you mentioned that geopolitics is pretty difficult to measure. Why is that and how do you grapple with that issue?

    Eric Van Nostrand: Most of the investors at BlackRock, who use macroeconomics to forecast trends in the economy that matter for financial markets, are doing it from a quantitative perspective, or they're doing it with things that can be measured quantitatively. We're trying to figure out what's happening with growth. We're trying to figure out what's happening with inflation. We're trying to figure out what's happening with unemployment. There is a deep academic literature from the economics community and from the market research community on how to measure those impulses and how to understand their likely path forward. Geopolitics is different. Geopolitics is the most purely qualitative input to our investment process that we can imagine. I know that China is a topic today, and I know that China was a topic in May 2018. But it's hard. It's not obvious for me to measure how different, quantitatively, the impact of China is in those two different periods. And that's really the frontier of our research on these issues are trying to attack that hard question and try to start measuring those topics.

    Catherine Kress: Got it. And so, you mentioned deglobalization. That seems like one of the biggest themes that I can imagine that might be one of the more difficult ones to measure. How do you actually, as an investor, define deglobalization and then begin to actually process that and its impact on markets?

    Eric Van Nostrand: Sure, so what the trend of globalization has meant over the past couple years has had a lot of important primary and secondary effects on the way we investors think about the evolution of financial markets. And the reversal of those trends recently are equally important for a number of different reasons. The first is trade flows. When economies are working closer together, when trade lines are open, the obvious first-order impact of that is that countries are going to import and export more with one another. That trade flow is itself an important source of growth. It boosts productivity growth because countries can focus more on their comparative advantage and deploy their labor and capital in more productive ways. That's something that benefits markets but also incomes across the distribution of incomes in all sorts of global economies. As we've seen over the past couple years, as countries have become less inclined to work with one another, and more inclined to put up barriers between trade, a lot of those positive trends for the economy risk getting a lot worse. This is a particularly worrying time for global productivity growth. Since the global financial crisis, productivity growth has slowed meaningfully, and economists don't have a lot of great answers about why, particularly in this period, where we look at the reach of the internet around us and it feels like we're innovating more. But economists say that productivity has been slowing according to the data. This is a big downside risk that could result in much lower productivity growth going forward. And that has implications not just for market returns, but for all participants in the global economy.

    Catherine Kress: What's the timeframe that we're thinking about here? Is this something that we're seeing happening now, over the next couple of months, or do you think it's going to take years or maybe even decades to play out?

    Eric Van Nostrand: That's a great question, Catherine, and that really gets at the crux of the different ways we think about different geopolitical issues. Deglobalization is something we view as a strategic theme that we expect to emerge over the next couple of years. I'm not going to change my clients' investment profile based on my view of how a certain bit of trade negotiation is going to unfold over the next week or so. That's not something that, in investment parlance, I have any edge on. What this trend reflects is the change in the way global trade is perceived over the next couple years, and that's something we're going to be watching closely.

    Catherine Kress: That makes sense, so it's not just about China. There's something much deeper and broader going on here.

    Eric Van Nostrand: China's obviously been the flagship of the deglobalization tension over the past couple months but as we've seen with the Trump administration's relationship with Mexico and the threatened tariffs there and the specter of auto tariffs in Europe as an example, it's clear that this is a tool that within the United States, the Trump administration plans to use on an ongoing basis even beyond China. But even beyond all that, it's not just Trump. Related to broader trends of political populism and what it's meant for attitudes toward global trade, we're starting to see other economies begin to talk about and, in some cases, take some protectionist measures. That means that this is something that's going to outlast Donald Trump. It's going to outlast the current round of U.S.-China trade spat. And it's going to be important to the conversation for years to come in our view.

    Catherine Kress: So shifting gears a little bit, Iran has been front and center in the headlines recently. That and trade seem to be dominating conversations. May marked the one-year anniversary of the U.S. pulling out of the Iranian nuclear deal, and just within the last month or two, we've had a series of attacks on oil tankers in the Persian Gulf and off the coast of Yemen, an Iranian attack on a U.S. drone and retaliatory cyber-attacks by the U.S. on Iran. We also saw a somewhat incredible series of events in which President Trump called off air strikes against Iran at the last minute. Between this, trade talks, one thing that's been very interesting to me is how well riskier assets are performing. I would have expected a much rockier road, frankly, given all these geopolitical tensions, but the U.S. equity market, for example, has returned to all-time highs. What's your view on what's going on here?

    Eric Van Nostrand: That's a really important point because it illustrates something we can't forget as we're having this conversation. We just talked a lot about how geopolitics matters—and it does, and it matters more than it used to. But it's still not the only thing that matters. The past couple weeks of equity market performance in the United States have been principally driven by an increased expectation of central bank action from the Federal Reserve and other global central banks to keep monetary policy easy by keeping interest rates low. That's not unrelated to geopolitics. In fact, it's in large part a reaction to some of these geopolitical tensions that have manifested globally, but it underscores the fact that those easing moves by the central banks, which are having a positive impact on asset prices today, are in the past couple weeks mattering more than the worries about geopolitics themselves. That's if you look over the past two weeks. If you look over the past eight, you see a different picture as geopolitics has been the real driver.

    Catherine Kress: You're an investor who actually has to make decisions about your portfolios with geopolitics in mind. What's your starting point?

    Eric Van Nostrand: As I said before, the principal challenge is that this feature, geopolitical risk, is really hard to quantify relative to conventional macroeconomic variables like growth and inflation. In our broader investment process, we use a lot of modern quantitative techniques like various forms of artificial intelligence and various forms of machine learning to forecast economic data and get a sense on what it means for asset returns. We don't have an artificial intelligence algorithm that's going to predict what Kim Jong Un is going to do in the next six months. That remains well beyond the capabilities of the quantitative investment community. We have developed over the past few years an indicator that we lovingly refer as the BGRI, the BlackRock Geopolitical Risk Indicator. What the BGRI measures is how much attention markets are paying to a given geopolitical risk. When our BGRI is high, that tells us that markets are very focused on geopolitics and that worries about geopolitics are likely in the price already. That means that we don't need to worry as much about a big downside tail event because the market's already on it. Things are already priced. When a BGRI is low, the market's not paying close attention to a particular risk, so if our geopolitical research team thinks that risk is a real one, then we better watch out because the markets are likely not discounting it.

    Catherine Kress: How do you actually build that indicator? What's the process that goes into creating it?

    Eric Van Nostrand: Thank you, Catherine. I love it when people ask me these methodology questions because I get to geek out about our research processes, and I'm pretty proud of this one. This is a great use and one of our flagship uses of what's typically called big data or unstructured data. What does that mean? It means we subscribe to and read in our systems, a tremendous amount of global news articles and financially-oriented publications. We scrape and read a tremendous amount of broker reports published by Wall Street firms and other research outfits that reflect the market topic of the day, and we zoom in on social media, look for accounts on Twitter that tend to discuss finance and look at what they're talking about. We use the same artificial intelligence tools we use to design quantitative signals around macroeconomics to measure how much those market sources are talking about geopolitics. The theory behind that is when they're talking about it a lot, that's an indicator to us that the market probably already knows about it. It's not a secret. When they're talking about it very little, that's when we tend to be a bit more on the defensive.

    Catherine Kress: Are there ever instances where we might interpret a particular geopolitical issue or event as being not so great, but it turns out to be positive for markets? And I guess with that question, how might the BGRI help us identify that disconnect?

    Eric Van Nostrand: Yeah, so that's something that happens a lot in analyzing the interplay of geopolitics and markets. The classic example of that is the 2016 U.S. presidential election. It had been widely forecast leading into November that the election of President Trump, were it to occur, would be a negative for risk assets because of associated uncertainty. As we know, that wasn't the case. The expectation of his tax and infrastructure policies when he was elected, wound up driving markets higher, in combination with the expectation of lower interest rates which are also central to equity prices in general. So sometimes you get market responses like that that are based on a different interpretation of the geopolitical event than you had before. But other times, and this is where the BGRI comes in, you might see a negative event happen that was already priced in before the event were to occur. An example of that might be the first round of U.S.-China tariffs in 2018. It was kind of telegraphed that this was starting to come. The BGRI rose as markets talked about it and then when the tariffs were actually imposed, it wasn't that big a surprise, and markets weren't damaged by that too meaningfully because it was already priced in. And that's really where we focus a lot of this research is understanding when markets price this in and when they don't, because that helps us understand the profile of risks that'll drive our investments overall.

    Catherine Kress: Sure, so if I were sitting on my couch starting season 1 of Game of Thrones, could I use this methodology to forecast who would take the Iron Throne at the end of the series?

    Eric Van Nostrand: I don't think anyone could forecast that, certainly given how things panned out. But I do think what something like the BGRI could tell us if we ran it in Westeros is who the consensus choice was going in, who the broad expectation was would wind up on the throne, if you will. And in the case of the real world or in the case of Westeros, we might think oh, if the market's crowded, if everyone expects it to be Daenerys, then perhaps there's a potential for surprise that we're not appreciating. And that I think would have, avoiding spoilers, that would have paid off in both Game of Thrones and the markets I suppose.

    Catherine Kress: So if we had actually created a dashboard for Game of Thrones, and we qualitatively said that we thought it was going to be someone else that wasn't Daenerys, but market attention on Daenerys was high—that would have been an interesting point to flag where we could have taken advantage of some opportunities.

    Eric Van Nostrand: That's exactly right, Catherine, and that's a great analogy for what we do when we think about geopolitical risks at BlackRock. We're never going to put a lot of risk on things that are inherently uncertain, such as the output of a lot of these geopolitical risks, but we're always going to be exposed to them. And what we need to understand is the way the markets are likely to respond in different scenarios so that we have a balanced allocation of risks, and exactly the process you laid out is just how we might think about that.

    Catherine Kress: Taking it back to the real world outside of the Seven Kingdoms, where does the BGRI sit for the risks we talked about earlier? So I know we have BGRIs for each of our top 10 risks that we track but, for example, global trade, U.S.-China competition, Gulf tensions, what are those indicators telling us?

    Eric Van Nostrand: Perhaps unsurprisingly, Catherine, all the risks we talked about are risks that the market isn't missing. And the BGRIs for each of those three topics are all very high. And they all say that, for example, the market attention to each of those topics is significantly higher than it has been in recent years, and that's not a surprise because we're talking about them, too. Those are the popular topics right now. And let me be clear. I don't mean we shouldn't be paying attention to them. Those are real risks in all three cases, and all three will be very important to markets over the coming years. But we think markets have largely appreciated the fact that these are happening in the background, sometimes not even the background, and are already getting the focus they need. Where we tend to worry is when we have a view that a certain geopolitical risk is on the horizon, but markets aren't paying as much attention to it.

    Catherine Kress: Alright, Eric, I'm going to end with a rapid-fire round. In one sentence or less, I want you to answer the following questions. Are you ready?

    Eric Van Nostrand: Let's do it.

    Catherine Kress: What is the market missing?

    Eric Van Nostrand: One geopolitical risk the market has paid less attention to recently is North Korea, which drove the focus in 2017 and 2018 but has since fallen out of the conversation.

    Catherine Kress: We just spent a lot of time on geopolitics. What about just politics?

    Eric Van Nostrand: One sentence on just politics? I would say domestic politics matter as much for the micro as they do for the macro; watch specific industries for their relationship with the policies proposed as we approach the election next year.

    Catherine Kress: Perfect. What about the macro environment?

    Eric Van Nostrand: Well, I think growth is slowing, but the markets know that, and central bank policy is working hard to offset it.

    Catherine Kress: Final question, a bit of trivia for you. Sansa Stark in Game of Thrones is played by an English actress named Sophie Turner. Who is Sophie Turner married to in real life?

    Eric Van Nostrand: The Jonas brother. I can't name my Jonas, though.

    Catherine Kress: Which one?

    Eric Van Nostrand: Hard pass, hard pass there.

    Catherine Kress: Alright, the answer is Joe Jonas.

    Eric Van Nostrand: I'll keep that in mind.

    Catherine Kress: Eric, thanks so much for joining us today. It was a pleasure having you.

    Eric Van Nostrand: Thank you.