Monthly Market Outlook
Managing risk in a world of conflict
November 2023 (Click here to download)
When prominent New York hedge fund manager Bill Ackman revealed at the end of October that he had closed his short position on US government bonds, his comments helped move the $24 trillion US treasury bond market.1
The billionaire founder of Pershing Square said, “there is too much risk in the world to remain short bonds at current long-term rates,” and suggested investors will increasingly turn to bonds as a safe haven because of growing geopolitical instability. US Treasury bond prices jumped sharply after his social media post, which is quite astonishing given that one person’s views would not normally be able to affect such a huge market.
This is a stark illustration of how fervently investors are searching for signals in the current environment of macroeconomic uncertainty and geopolitical risk.
As investors, we must be mindful of all sources of risk, and geopolitical risk is increasing with escalating conflicts, which come at a heavy cost to human life.
The last 40 years have been relatively stable from a geopolitical perspective. The end of the Cold War, China’s entry into the World Trade Organisation, followed by accelerating globalisation combined to create a benign environment in historical terms.
Today, things have changed, and all investors now need to pay attention to geopolitical risk.
How geopolitical risk has affected markets
Gold, traditionally seen as a safe haven asset in times of uncertainty climbed to 1,990 US$/oz (as of 1 November), up from 1,830 US$/oz at the start of October, on increased geopolitical risk.
Brent and WTI crude oil also rose as traders priced in the risk to global oil supply of an escalation in the Israel-Hamas conflict to the wider Middle East. The risk to the regional natural gas market is more direct, with Israel being a large supplier. A material fall in exports could impact Europe’s liquefied natural gas supply over winter – the price of TTF, the European benchmark for natural gas, has risen by over 30% since 5 October.
The VIX Index, nicknamed ‘the fear index’, is a measure of the expected volatility in US stocks over the next 30 days. It is often used as a bellwether for investor sentiment. The VIX has risen to its highest level since the first quarter of the year, US stock prices have dropped, and the price of equity options has risen as investors looked for ways to hedge risks.
The Manager notes, however, that the VIX has not spiked as dramatically as one might expect, and certainly less than at the start of the Russia-Ukraine war, as the chart below shows.
Public and private global climate finance needs to increase dramatically to secure a 1.5C outcome
Putting the market impact of recent events into context
We continue to analyse and forecast the range of possible outcomes, including worst-case scenarios, and their potential impact. While we are not making portfolio changes directly in response to rising geopolitical risks, we are taking the time to make sure portfolios are properly diversified and reassess all the investments we hold with an eye on risk.
Changing corporate behaviour in Japan
Elsewhere in the world, we are seeing some positive change. Corporate behaviour has been shifting in Japan since the Asian financial crisis 25 years ago. It has been a long time coming, but now indebted Japanese companies are taking a different approach to capital allocation and spending.
Japanese equities were considered a bit of a ‘value trap’ in recent years, meaning they were cheap for good reason, but improving corporate governance and a supportive economic backdrop now makes these stocks look more appealing. The Manager sees strong potential for Japanese equities to appreciate in the medium to long term.
Sector in focus: Utilities
Over the last year, the global utilities sector has been one of the weakest performers relative to the broader market. The sector relies heavily on debt financing to increase revenues, so a higher interest rate environment has made its debt more expensive and hindered performance.
Utilities stocks have defensive qualities because they often pay high dividends, but as government bond yields have risen, utilities have faced greater competition from these and other income-generating assets.
The Manager thinks new legislation and technological improvements should underpin earnings growth in the sector. Decarbonisation policies and subsidies to invest in clean energy in the US and Europe should create a backdrop for broader investment which will benefit utility companies. For instance, the Biden administration’s Inflation Reduction Act has pledged USD 400bn of investment in green energy.
Utilities sit at the epicentre of the green energy transition.
Global risks are rising and, through the lens of an investor, we need to think about how we position ourselves for an uncertain environment. The Manager believes diversity with downside protection and active management continues to be the best way to maximise the chance of investment success.
1 US outstanding treasury securities by type 2022 | Statista
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