Geopolitics
Western policymakers are pursuing three capital “T” Truths: China is evil, climate change is a major risk, and Russia is… also evil. Pursuing all three priorities at the same time presents a version of the classic “impossible trinity.”
October seasonality tends to be negative for stocks in an election year. That is the only thing that has stayed our hand from shifting out of our tactical underweight on US equities, initiated – poorly – in July.
But the big macro news from September has not been bearish. The Fed has signaled jumbo cuts. Within seven weeks, the US central bank intends to cut by 100bps! Meanwhile, China appears to have reached a “policy bottom,” with its September 26 Politburo meeting signaling an extraordinary rhetorical shift towards fiscal policy. As such, we are starting to sniff out global reflation, akin to the 2015-2016 mid-cycle slowdown.
The labor market data still worries us. It is clearly deteriorating, on paper. Is it because of an imminent recession or “normalization?” It is difficult to say. We are open minded.
Finally, the Middle East tensions are again on the horizon. If Iran stays its hand against Saudi energy facilities – which we expect it to continue to do – the Iran-Israel conflict is a sideshow. Nonetheless, with global reflation afoot, we went long oil last week, on September 26. As such, geopolitics is a neat tailwind to that call.
Our quant model shows Democrats winning the election at a 56% probability, with 303 electoral college votes. But swing state economies are slowing and Democrats’ odds in Michigan fell. Trump can win with Georgia, Michigan, plus one other state. Neither the Fed nor China’s stimulus should reduce one’s odds of a Republican upset.
Markets are rallying on Fed rate cuts and China stimulus but there will also be October surprises ahead of the US election, which Trump could still win. Russia’s conflict with the West is escalating and the Middle East is destabilizing further. Investors should favor US bonds but they should add some risk in emerging markets in response to China’s policy turn.
As we head into a more turbulent macroeconomic and geopolitical period, investors should favor countries with newly elected government, small government size, and ample room to cut policy rate. Ideally, they should also be in a stable region, and not so dependent on the US or China. Hence, we are introducing the Global Political Capital Index as a way to integrate these factors into a score that can help narrow down the countries with the best and worst abilities to deal with the incoming challenges.
Investors should de-risk tactically in expectation of shocks and surprises ahead of the US election and an uncertain aftermath. Democratic victory with a gridlocked Congress is our base case but would bring minor tax hikes and nuclear brinksmanship with Russia. A Republican single-party sweep offers huge tax cuts but also a global trade war. Recession looms regardless.