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The views expressed are those of the authors at the time of writing. Other teams may hold different views and make different investment decisions. The value of your investment may become worth more or less than at the time of original investment. While any third-party data used is considered reliable, its accuracy is not guaranteed. For professional, institutional or accredited investors only.
After several decades of ever closer interconnectedness between the world’s economies, our research suggests that we are entering a new, more volatile regime, with greater divergence between countries. This pullback from globalisation is often viewed through a negative lens, but from an asset allocator’s perspective, we think a more nuanced approach is appropriate. Below we explore the macro picture driving this greater dispersion between economies and set out some of the key implications for portfolios.
From a macro perspective, this new regime involves structurally higher inflation, shorter and more volatile cycles, reduced availability of labour and fractured global supply lines, all intensified by increased geopolitical rivalry and climate change. And while globalisation reduced income inequality across countries, it greatly increased it within countries. Now, the consensus around an increasingly globalised world is openly being called into question. Governments have started to pursue policies that support domestic demand and industry in critical areas such as energy transition and technology in a context of rapidly increasing trade restrictions (Figure 1), further accelerating divergence. Central banks are also likely to diverge in line with shifting domestic cycles and government policies.
Despite the above, markets continue to price for economic convergence and central banks staying in a tight pack, led by the US Federal Reserve (Fed). The market’s expectation (Figure 2) appears to be that the Fed will continue to lead the hiking and subsequent cutting cycle, with other central banks, to varying degrees, following suit, albeit with a lag, while the Bank of Japan stays on hold. That’s been the pattern since 1998 and the market currently appears to believe it will always be thus.
Three factors may help to explain this continued belief in Fed-led policy convergence:
Prior to the late 1990s and particularly during the 1970s and 1980s, other countries had their own domestic demand cycles, with substantial variation in growth (real and nominal) between countries and no significant outliers in real and nominal consumer spending. At times, fiscal and monetary policies also moved in very different directions and by some margin.
While well-established paradigms take time to shift, our work points to a high chance that we are moving back to this previous environment. Key developments to note in this context are:
Already, the services sector rather than manufacturing is leading growth in each of these regions, and if, as we believe, the domestic demand stories take hold, the interlinkages between different economies and market pricing will change, with major implications for long-term rates and a range of assets.
From an asset allocation perspective, higher volatility and dispersion between regions has multiple implications, and counterintuitively, these are not all negative. Volatility creates higher risk but also opportunity, hence asset allocators need to think carefully about how they adapt their portfolio approach.
On the positive side of the balance sheet, a divergent regime provides:
On the negative side, reduced correlations come at a price:
To prosper in this new regime, we think investors need be highly deliberate and systematic in their portfolio construction, with the above risks and opportunities in mind. This includes thinking about:
Based on our research, we believe we are returning to a world of macroeconomic divergence. Investors should prepare for that eventuality and use the above considerations to help adjust their asset allocation.
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