The US S&P 500 index is close to its record high hit in August. Asia and non-Asia EM indices, which have outperformed Developed Markets this year, are testing key resistance and both the Euro area and Japan stock indices look as though have formed a double bottom and could rally further. So all looks rosy in the very short term.
The longer term picture looks more worrying, however. The US economy looks to be in the late stages of its economic expansion phase with no clarity on who would pick up the economic growth baton should the US fall into recession (which we believe is a one in three risk over the next 12 months).
As concerning are recent political and geopolitical developments. The Brexit vote was important in two aspects, both of which are likely to resonate in upcoming political contests in Europe and the US.
First, Brexit is symptomatic of the global trend for rising populism and increasing distrust of the economic and political elite. The UK’s new Prime Minister has already responded by promising more egalitarian policies to address this. Trump is promising similar things in the US and centrist parties are losing ground in many European countries — the rise of the Five Star Movement (which favours a referendum on Euro area membership) in Italy comes at an interesting time given the challenges in the banking sector and a forthcoming referendum on constitutional reform. This does not appear to be an environment where capitalists and investors are likely favoured over workers.
Second, at the geopolitical level, the European Union was a response to two 20th century European conflicts that left millions dead. It is way too early to say that Brexit (assuming the UK government goes through with it) will lead to the EU’s or even the Eurozone’s demise, but it is clearly significant and is likely to raise tensions both between the UK and the rest of the EU and within other EU members themselves.
Again, how the EU and Italy negotiates a banking sector bailout will be absolutely critical to the future of the EU. While the UK was always an outsider to Europe (or a thorn in the EU’s side), Italy has always been viewed as a core member. If the EU loses the PR battle in Italy, the consequences may well be terminal for the EU project as we know it.
As important as the above factors are, the recent arbitration ruling in the Philippines case against China’s territorial claims and activity in the region could be even more important. We have been talking about the risks that a multipolar world brings and the risks of rising tensions in Asia, in particular. This ruling brings this to the forefront. Add to this the increasingly strident rhetoric (and action) in the Korean peninsula and the Indian subcontinent, and the geopolitical risks have risen markedly in recent months.
Therefore, there are still a lot of more worrying longer term trends that investors should take into consideration. We have argued this warrants either a more balanced approach to investing and/or more tactical investments. On the latter, defence stocks are not the cheapest in the world, but perhaps they are expensive for a very good reason.
-- Steve Brice is Chief Investment Strategist at Standard Chartered Bank’s Wealth Management unit.)