Russia & EM Europe
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.
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.
Investors should buy protection against further volatility. The shakeup in early August was a taste of things to come. The US election is a pivotal moment in modern history that will drive up uncertainty, while other countries take advantage of US division and distraction.
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.
The death of the Iranian president reinforces our base case view of Middle Eastern instability and at least minor oil supply shocks. Rapid geopolitical developments in recent weeks are pointing to a new bout of global instability. The US is hobbled by its election. Conflicts with Russia, China, and Iran are all now escalating at the same time, at least marginally. Investors should reduce risk and shift to more defensive assets, markets, and sectors.
In the near term, favor oil and oil producers outside the Gulf Arab states. Over a 12-month horizon, favor US and North American equities, defensive sectors over cyclicals, and safe-assets. Within cyclicals, stick to energy and defense.
Investors around Europe and North America are concerned that the stock market is increasingly overbought and vulnerable to exogenous risks. We agree and have good reasons to fear that festering geopolitical risks and the US election season will deal negative surprises.
Commodity volatility will continue its rising trend since 2014. The US is on the brink of a major election, the outcome of which could reduce its willingness to engage with the outside world. So, states seeking to carve out their own spheres of influence are incentivized to raise the economic costs to the US and discourage its influence in their regions. These states can do this by interfering in key trading routes in their regions. As a result, geopolitical threats to maritime chokepoints are a structural as well as cyclical problem and will persist due to the revival of superpower competition.