Like many others, the world"s largest money manager with $5.9 trillion in (ETF) investments, BlackRock, is not too worried about a market which no matter what, promptly rebounds from any and every selloff, and seems to close at all time highs day after day as if by magic. To be sure, BlackRock"s employees are delighted: the less the volatility, and the higher the S&P goes, the more likely retail investors are to hand over their cash to BlackRock. So far so good. Still, not even Blackrock can state that after looking at this chart, which unveils unprecedented economic policy uncertainty at a time when equity uncertainty has never been lower...
... that everything is ok.
And it doesn"t: in a blog post by BlackRock"s Isabelle Mateos y Lago, Blackrock"s chief multi-asset strategist writes that while markets may be a sea of calm, geopolitics are anything but. As a result, the world"s biggest ETF administrator has its eyes on 10 geopolitical risks and is tracking their likelihood and potential market impact, as it wrote recently in the firm"s Global Investment Outlook Q4 2017.
The "world of risk" map below is a quick snapshot of all
Among the Top risks tracked by Blackrock are:
- North American trade negotiations
- Russia-NATO conflict
- South China Sea conflict
- US-China tensions
- Escalations in Syria and Iraq
- North Korea conflict
- Fragmentation in Europe
- Gulf conflicts
Of the risks listed above, which are the ones BlackRock is most worried about? According to Mateos y Lago, the top three right now: North American trade negotiations, a North Korea conflict and U.S.-China tensions, with the second and third particularly interrelated.
The details:
North American trade negotiations
The fourth round of North American Free Trade Agreement (NAFTA) renegotiations ended this week, with Mexico and Canada rejecting what they view as harsh U.S. proposals. Still, news reports did suggest apparent progress on less contentious parts of the agreement, and the negotiations aren’t over. The next round of talks are scheduled to take place in Mexico next month.
Our base case is that successful negotiations will be completed in early 2018. However, our hopes for this outcome have recently diminished given tough positions from U.S. negotiators and threatening rhetoric from U.S. President Donald Trump that has resulted in greater uncertainty. Market risks are biased to the downside given that a good outcome is priced in, in both Canadian and Mexican markets.
* * *
North Korea
We view North Korea’s missile and nuclear weapons program as a major threat to regional stability, U.S. security and nuclear non-proliferation. The possibility of armed conflict has risen, we believe, given North Korea’s missile launches over Japan, a nuclear test and an intense war of words. This has raised the chance of misstep or miscalculation, and we could see limited action such as the shooting down of missiles.
Yet we currently see a low probability of all-out war; the costs are too high on all sides. Instead, we expect the U.S. to intensify its “peaceful pressure” campaign, evident in imposing unilateral sanctions and leaning hard on China to participate. We see the crisis straining U.S.-China relations just as economic tensions are rising.
* * *
Deteriorating U.S.-China relations
We see frictions between the U.S. and China heating up over time. The countries risk falling into the “Thucydides Trap,” a term coined by Harvard scholar Graham Allison to describe clashes between rising powers and established ones. We see trade and market access disputes straining an increasingly competitive U.S.-China relationship in the long run, and believe markets have yet to factor in this gradual deterioration.
In the short term, tensions could rise if Chinese President Xi Jinping pursues an even more nationalistic agenda in the wake of the National People’s Congress. Economic tit for tats could lead to an erosion of relations—and have sector-specific effects.
U.S. military action against North Korea and/or an accidental clash in the South China Sea would deal a blow to the relationship, in our view, and hurt risk assets. But our base case is that the U.S. and China avoid these land mines in the short term, and try to use President Trump’s upcoming visit to emphasize cooperation.
Taking the above in context, what is BlackRocks recommendation for portfolios? The good news, according to the author, is that most geopolitical shocks have short-lived market impacts, except in regions directly affected. For those who wish to hedge, Blackrock recommends government bonds as useful diversifiers against volatility and equity market selloffs sparked by such shocks.
* * *
Meanwhile, in a separate observation, Rick Rieder, Blackrock"s global fixed income CIO pointed out another recurring, and ominous trend: "major central banks flooded global financial system with near $10T in liquidity since 2008, but now we’re beginning to unwind"
Indeed, major central banks flooded global financial system with near $10T in liquidity since 2008, but now we’re beginning to unwind pic.twitter.com/utyHoZZeco
— Rick Rieder (@RickRieder) October 19, 2017
... which leads to the question: "will others (foreign-exchange reserves, banks) step in to provide liquidity, so the transition doesn’t derail growth?"
Question is: will others (foreign-exchange reserves, banks) step in to provide liquidity, so the transition doesn’t derail growth? (3/4) pic.twitter.com/lKimYZRIVi
— Rick Rieder (@RickRieder) October 19, 2017
The answer: it all depends on China.
We think so; financial condition drivers (monetary base, USD, money multiplier) should be supportive, yet so much depends upon #China (4/4) pic.twitter.com/lr7kSKzsJO
— Rick Rieder (@RickRieder) October 19, 2017
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