Geopolitical Regions
The decision by GeoMacro team on July 2 to short USDJPY and underweight equities has proven to be prescient. We still do not like the market setup from here on out. A recession would, obviously, be negative for risk assets. But even if investors avoid that scenario, the transition from cash- to leverage-driven growth is unlikely without a significant Fed rate-cutting cycle.
The war in the Middle East is expanding, upgrading our subjective odds of a major oil supply shock to 37% and underscoring our 60% odds of Republican victory in November. Volatility should spike again as investors contemplate the prospect of rising oil prices amid slowing US and global growth. Tactically investors should stay overweight energy stocks relative to other cyclicals and favor oil producers in the Americas rather than Middle East.
Oil markets will not be impacted by Venezuela in the near term, but by shocks from the Middle East. Maduro’s ability to stay in power in the short-term removes an avenue of oil supply relief. The same avenue is cut off if Trump is reelected. Geopolitical shocks in Venezuela could present tactical buying opportunities for Chile, Peru, and Colombia.
Investors should overweight US assets and de-risk their portfolios in anticipation of a major increase in policy uncertainty and geopolitical risk surrounding the US election and its global ramifications.
A global economic downturn will be a headwind for natgas prices over the cyclical horizon. Thereafter, LNG capacity additions will help keep the market in balance into the end of the decade. That said, Europe’s increased dependence on global LNG flows raises its exposure to market dynamics in the rest of the world. This will keep volatility elevated versus pre-Ukraine war.
Investors in European sovereign bonds should find solace that continental voters are not turning away from support for EU integration. As such, populist parties are not really that “far” left or right. And as long as they want to maintain popular support, they will have to abide by the fiscal rules imposed by Brussels. No such supranational constraint exists in the U.S., the real risk for global bond operators.
The Labour Party’s comeback in the UK is widely expected and will lead to fiscal stimulus consisting of increased public spending with minimal tax hikes. But a sweeping single-party majority will reduce social unrest only at the cost of higher taxes over the medium term. The paradigm has shifted away from the Thatcherite low-tax regime of the now-discredited Tories. v
In Section I, we examine some concerning signs of US economic weakness that emerged in June. We also discuss portfolio positioning in the face of falling interest rates and cross-check our recommended US equity overweight in the face of extremely optimistic expectations about AI’s impact on growth. We conclude that defensive positioning continues to be warranted. In Section II, we dig into those optimistic expectations for AI. We find that the US equity market is significantly overvalued unless the deployment of AI technology causes a 10-to-20 year productivity surge in line with what occurred during the IT revolution of the 1990s, with persistently high margins on the revenue generated from the improvement in growth. We doubt that AI will end up truly boosting economic activity by this magnitude.