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GLOBAL WEEKLY COMMENTARY

Geopolitical risks on our 2020 radar

Key points

U.S.-Iran tensions
The recent sharp escalation in U.S.-Iran tensions serves as a reminder of the potential for flare-ups in geopolitical risks as we enter 2020.
Growth outlook
We see growth stabilizing and gradually picking up over the next six to 12 months thanks in part to easy financial conditions.
U.S.-China deal
Strategic competition between the U.S. and China, especially in tech, is likely to persist despite a limited "Phase 1" trade deal.

U.S.-Iran tensions have spiked in recent weeks with the U.S. killing of a top Iranian military leader triggering retaliation. This reminds us of still heightened geopolitical risks across many dimensions, even as we see a relatively benign backdrop for risk assets in 2020. The U.S.-China trade conflict – 2019’s dominant geopolitical risk – has paused, yet we expect enduring strategic rivalry between the two countries. We see U.S. Treasuries as a key source of portfolio ballast.

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Chart of the week
BlackRock Geopolitical Risk Indicator-Global, 2005-2020

BlackRock Geopolitical Risk Indicator-Global, 2005-2020

 

Sources: BlackRock Investment Institute, with data from Refinitiv. Data as of January 3, 2020. Notes: We identify specific words related to geopolitical risk in general and to our top-10 risks. We then use text analysis to calculate the frequency of their appearance in the Refinitiv Broker Report and Dow Jones Global Newswire databases as well as on Twitter. We then adjust for whether the language reflects positive or negative sentiment, and assign a score. A zero score represents the average BGRI level over its history from 2003 up to that point in time. A score of one means the BGRI level is one standard deviation above the average. We weigh recent readings more heavily in calculating the average.

The market’s overall attention to global geopolitical risks sits at elevated levels, as proxied by our BlackRock Geopolitical Risk Indicator (BGRI). See the chart above. Our BGRI measures the attention to top 10 risks in analyst reports, social and financial media. We had raised the likelihood of growing Gulf tensions late last year, and still see ongoing and heightened tensions despite the avoidance of major confrontation between the U.S. and Iran. The market reaction to date to Gulf tensions has been muted, partly reflecting the decreasing heft of the Middle East in determining global oil prices, with the U.S. now a net oil exporter. Yet a sustained escalation that results in repeated attacks on oil facilities or disruptions to shipping in the Persian Gulf – more materially threatening global growth – would likely change this story.

We see a relatively benign backdrop for risk assets in 2020, with easier financial conditions supporting a growth uptick. Read details in our 2020 Global Outlook. A key underpinning assumption is that global trade tensions move sideways this year. Recent developments in this area have been positive for markets: U.S.-China trade tensions appear to be going sideways, and the U.S.-Mexico-Canada Agreement on trade looks set to pass the U.S. Congress soon. Yet any broader surge in geopolitical risks in the Middle East or elsewhere could undermine the sentiment in – and the performance of – risk assets. What other geopolitical risks should we look out for in 2020? Below we detail three broad dimensions.

First: We are seeing fragmentation at a global level across a range of dimensions, including ideology, trade and technology. Technology decoupling between the U.S. and China is underway and will force countries and businesses to navigate this evolving landscape. We expect such tensions to persist even after a limited “Phase 1” trade deal that may temporarily defuse U.S.-China trade tensions. Domestically, political polarization is reaching a high point in many countries. The U.S., for example, faces a contentious presidential election with the potential for starkly divergent policy outcomes. We have downgraded U.S. equities to neutral on a tactical basis amid rising election uncertainty. The second is an increase in global protests, partly fueled by rising income and wealth inequality and facilitated by social media. Many governments are ill-equipped to respond. With limited monetary and fiscal maneuvering room, this could lead to further unrest in any downturn.

The third is cybersecurity. Tensions are elevated between the U.S. and many adversaries such as Iran and North Korea, which have the capability to mount attacks on critical infrastructure and institutions. An uptick of “ransomware” attacks against cities and states with relatively poor defenses may be a sign of things to come. Markets look to be complacent about such risks: the attention to cyber attacks has been on a steady decline since late 2017, our BGRI shows. U.S. Treasuries and their inflation-protected peers have done well to cushion portfolios against recent risk selloffs – and we prefer them in both tactical and strategic portfolios. Government bonds in Europe and Japan have diminished ability to serve such as role as their yields near lower bounds.

Recession risks
We see limited recession risks for the next 12 months.
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Assets in review
Selected asset performance in the past 12 months

Selected asset performance in the past 12 months

 

Past performance is not a reliable indicator of current or future results. It is not possible to invest directly in an index.
Sources: BlackRock Investment Institute, with data from Refinitiv Datastream, January 2020. Notes: The two ends of the bars show the lowest and highest returns over the last 12 months, and the dots represent returns compared to 12 months earlier. Emerging market (EM), high yield and global corporate investment grade (IG) returns are denominated in U.S. dollars, and the rest in local currencies. Indexes or prices used are: spot Brent crude, MSCI USA Index, the ICE U.S. Dollar Index (DXY), MSCI Europe Index, Bank of America Merrill Lynch Global Broad Corporate Index, Bank of America Merrill Lynch Global High Yield Index, Datastream 10-year benchmark government bond (U.S. , German and Italy), MSCI Emerging Markets Index, spot gold and J.P. Morgan EMBI index.

Market backdrop

An escalation in Middle East tensions has spurred a cautious start to the year for risky assets. Yet the broader backdrop remains relatively benign with trade tensions abating and financial conditions still accommodative. We are on the watch for more signs that global manufacturing may be bottoming out. We see the dovish pivot by major central banks as having run its course for now. We expect growth to stabilize and gradually pick up over the next six to 12 months as easier financial conditions start filtering through and sideways protectionist pressures give global trade activity some breathing room. See our macro data dashboard.

Week ahead

Jan. 14 – China trade
Jan. 15 – UK inflation; the U.S. and China due to sign “Phase 1” trade deal
Jan. 16 – Japan machinery orders
Jan. 17 – China industrial output and retail sales; University of Michigan consumer surveys; euro area inflation

The “Phase 1” trade deal would confirm a pause in the U.S.-China trade conflict that has weighed on global growth over the past year. Yet we have seen little progress toward resolving structural U.S.-China rivalry, and expect the strategic competition and technology decoupling between the two countries to persist in the longer term.

Directional views
Tactical views on major global assets from a U.S. dollar perspective, December 2019

Directional View

Note: This material represents an assessment of the market environment at a specific time and is not intended to be a forecast or guarantee of future results. This information should not be relied upon as investment advice regarding any particular fund, strategy or security.

Granular views
Tactical views on selected assets vs. broad global asset classes by level of conviction, December 2019

Granular View

Note: Views are from a U.S. dollar perspective. This material represents an assessment of the market environment at a specific time and is not intended to be a forecast or guarantee of future results. This information should not be relied upon as investment advice regarding any particular fund, strategy or security.

Read details about our investment themes and more in our 2020 Global outlook.

Growth edges up

 

We see an inflection point in global economic growth as easier financial conditions start filtering through.

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    • The growth mix is shifting as the modest pickup is likely to be led by manufacturing, business spending and interest rate-sensitive sectors such as housing.
    • We believe the U.S. and China have strong incentives to hit pause on their trade conflict across 2020, though there may be turbulence along the way. A “Phase 1” limited trade deal in principle between the U.S. and China as well as a revised North American trade pact should allow global trading activity some breathing space.
    • We see China’s economy stabilizing but little appetite among its leadership for large-scale stimulus. Europe and emerging markets should see higher average growth rates as they recover from a weak 2019.
    • The UK Conservative Party’s large election win gives Prime Minister Boris Johnson a mandate to deliver Brexit in January, but a difficult end-2020 deadline looms to negotiate a trade deal with the EU. We expect an extension.
    • Market implication: We maintain a moderate pro-risk stance and see potential for cyclical assets such as Japanese and EM assets to outperform tactically.
Policy pause

 

We see economic fundamentals driving markets in 2020, and less scope for monetary easing and other policy surprises. The lagged effect of policy easing should start to filter through to economic activity.

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    • The Federal Reserve reaffirmed last week that the bar for further policy easing is high — with no policy action barring a significant growth slowdown or an unwanted tightening in financial conditions.
    • The policy debate is set to zoom in on a potential shift from monetary to fiscal stimulus.
    • Any fiscal support in 2020 is likely to come from outside the U.S.: notably Europe and Japan, as well as EM ex-China. We see the U.S. presidential election overshadowing the U.S. fiscal policy debate in 2020.
    • The bottom line: We see little chance of meaningful fiscal stimulus, but believe even modest shifts toward fiscal easing may have outsized market impact.
    • Market implication: Income streams are crucial in a slow-growth, low-rate world. We like EM and high yield debt.
thinking resilience

 

This year’s sharp shift on monetary policy and interest rate expectations has pushed some bond yields near levels we consider as their lower bound, implying less room to fall during risk asset selloffs.

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    • A weakening or breakdown of the negative correlation between stocks and bonds could also undermine the portfolio ballast role of government bonds.
    • A focus on sustainability can also help make portfolios more resilient, in our view, by reducing exposure to environmental, social and governance (ESG) risks.
    • The U.S. killing of a top Iranian military leader in the Middle East marked an escalation in the U.S.-Iran conflict. The U.S. and Iran have stepped back from direct military confrontation. Attacks on energy infrastructure in the region or disruption in shipping would generate greater market impact, in our view. Generally, we believe markets are underestimating cyber risks. See our geopolitical risk dashboard.
    • Market implication: We prefer U.S. Treasuries to lower-yielding peers as portfolio ballast and like inflation-protected securities against inflation risks.
Tom Donilon
Chairman — BlackRock Investment Institute
Thomas E. Donilon is Chairman of the BlackRock Investment Institute. He served as National Security Advisor to President Barack Obama.
Mike Pyle
Global Chief Investment Strategist
Mike Pyle, CFA, Managing Director, is Global Chief Investment Strategist for BlackRock, leading the Investment Strategy function within the BlackRock Investment Institute ...
Scott Thiel
Chief Fixed Income Strategist, BlackRock Investment Institute
Scott Thiel, Managing Director, is Chief Fixed Income Strategist for BlackRock and a member of the BlackRock Investment Institute (BII). He is responsible for developing ...
Elga Bartsch
Head of Macro Research — BlackRock Investment Institute
Elga Bartsch, PhD, Managing Director, heads up economic and markets research at the Blackrock Investment Institute (BII). BII provides connectivity between BlackRock's ...