Politics, growth concerns and rising rates have been some of the key drivers of markets this year, and they are likely to play another starring role in the next 12 months, creating both risks and opportunities for investors.
This is according to Robert-Jan van der Mark, co-manager of the Kames Diversified Growth Fund, who notes that between Brexit, trade wars and labor market concerns there are several uncertainties for investors to navigate over the coming months.
Van der Mark reveals the key macro risks and the potential positives, beginning with monetary policy: ‘As an economic cycle reaches its end, capacity constraints typically start to emerge and inflation starts to increase. At this point, monetary policy error is one of the biggest risks.
‘Central banks could respond to rising inflation by tightening financial conditions, but this runs the risk of causing investment to reduce, leading to a dip in confidence and a fall in spending.’
Meanwhile, he notes higher rates could have a negative impact on highly leveraged corporations. ‘In such a scenario, government bonds are likely to outperform while riskier assets are likely to produce negative returns.’
When it comes to political risks, it is axiomatic to note that political uncertainties have been plentiful this year and a lack of clarity still abounds. ‘Closest to home is the risk of a failure in Brexit negotiations,’ notes van der Mark. ‘This could increase the likelihood of a hard Brexit and have a negative impact on trade between the UK and the eurozone.’
But the UK’s exit from the EU is not the only departure to be wary of, highlights van der Mark. ‘The recent Italian budget proposal and ensuing unrest highlighted the lack of structural stability in the eurozone and sparked concerns about a possible break-up of the union,’ he points out. ‘While we think this is unlikely, the risk will remain unless the eurozone integrates further.’
On trade war escalation, van der Mark already notes a full-blown trade war could rear its head if tensions between the US and China intensify: ‘This would almost certainly cause a global slowdown, impacting economies across the world.’
On positive surprises, he lists innovation. ‘A tighter labor market could spur investment, innovation and productivity-enhancing measures, creating a positive effect on the economy,’ he says. ‘This would see productivity growth revive, which would offset lower labor supply growth and help sustain global economic growth.’
In addition, if political risks start to dissipate, that can often act as a tailwind for the global economy. ‘If trade war rhetoric starts to soften and trade barriers are removed, for example, the euphoria that provokes could help drive global growth forward,’ notes van der Mark.
Other examples where a reversal could occur include a soft Brexit deal being agreed or structural reforms being implemented in the eurozone to promote convergence and stability. ‘Any of these political developments could provide a welcome tailwind for the global economy,’ says van der Mark.
‘In this scenario, risky asset classes such as investment in equities, commodities and real estate could generate high-single-digit or even low-double-digit returns. Returns from fixed income would be less positive, with government bond investments even generating negative returns because yields would rise.’
