- Co-Head of Investment Strategy
Asia ex-Japan, Institutional
Change
The views expressed are those of the author at the time of writing and are subject to change without notice. Other teams may hold different views and make different investment decisions. This content is for informational purposes only, should not be viewed as a current or past recommendation and is not intended to constitute investment advice or an offer to sell, or the solicitation of an offer to purchase shares or other securities. Forward-looking statements should not be considered as guarantees or predictions of future events. For professional, institutional, or accredited investors only.
Since the late 1990s, when the US cycle turned, the rest of the world generally followed, with a lag. As a result, central banks have tended to follow the US Federal Reserve’s (Fed’s) lead. However, the new economic era — with its greater volatility, higher inflation, and shorter and more frequent cycles — is likely to result in greater cyclical divergence between countries and the need for different central bank responses.
We are already seeing this play out — most notably between the Fed and the European Central Bank (ECB) — with the former continuing to signal its intention to keep rates higher for longer and the latter cutting rates in June. In a world of higher and more regionally variable inflation, our Investment Strategy Group anticipates continued policy divergence as central banks adjust rates to address their economies’ specific inflation challenges. In short, central banks will be forced to act independently.
This has implications for investors, with opportunities presenting themselves most prominently in interest-rate markets, but we think a more divergent world has ramifications beyond central bank policy. In fact, we see central bank divergence as one of only five ways for investors to think about divergence.
Divergence in geopolitics
Elevated geopolitical risk and deglobalisation are the new normal. International conflict, a deterioration in the US/China relationship and growing climate stresses will all contribute to shaping the geopolitical and macroeconomic landscapes. Our Thematic Team expects this to lead policymakers to place a high priority on three different facets of security: national security, economic security and resource security. We think each of these could shape spending decisions, trading relationships and supply chains and should persist across numerous election cycles.
To bolster national security amid competition that will span trade, economic policy, global diplomacy and military policy, we expect to see government spending on defence accelerate, producing a long-term tailwind across both the traditional and emerging defence sectors.
An increased emphasis on conomic security should lead to more promotion and protection of strategic industries via policy measures, export controls and legislative actions, and also nearshoring and the localisation of sectors such as semiconductor technologies and artificial intelligence.
Finally, countries are recognising the importance of stability, independence and resilience in natural resource supply, with both energy and critical minerals a particular area of focus.
Our Thematic Team believes these coming disruptions may offer significant, long-term opportunities to find winners at regional, country, industry and company levels. There are of course risks: a major conflict would likely have unpredictable implications for all capital markets. However, we believe that with proper management, these thematic allocations could provide investors with a more defensive and diversifying allocation within portfolios.
Divergence in markets
Greater volatility, higher inflation and increased divergence across regions, sectors and securities may challenge some of the roles that traditional asset classes have historically played. If inflation proves to be stickier than expected, the powerful diversification role that fixed income provided for equity allocations in the past may not be as reliable or at least not as consistent in this type of market regime.
We are not suggesting that investors necessarily turn their backs on popular multi-asset investment approaches like the 60/40 model, but we do think they should reassess the role of different portfolio building blocks. We also believe that there is a greater need for resilience in portfolios than in recent years, which makes a case for increasing the number of risk and return drivers.
Hedge funds can be a valuable consideration for investors who are looking to reassess the role of different portfolio building blocks, with the caveat that investing in hedge funds can sometimes entail greater risk. Our team has developed a role-based framework to help illustrate how different types of hedge funds may be able to fit within an existing portfolio.
Macro funds, for example, trade on trends in macroeconomic data or changes in economic policy and invest in different asset classes, potentially offering diversification and downside protection benefits amid divergence.
Divergence in active opportunities
Higher divergence can create opportunities for active managers, and in our view, the relative efficiency of markets can be a useful tool to identify the most promising areas. Our Fundamental Factor team has developed a market efficiency framework to help find those areas of opportunity. Based on their analysis, we believe active equity managers may have the greatest ability to add value in Japan, the small-cap market, emerging markets and non-US equities.
Divergence in emerging markets
Emerging market (EM) equity markets are highly diverse but becoming even more so in a divergent world. We think this could be one reason why quantitative EM strategies with tight risk constraints have recently tended to outperform. The EM universe significant breadth as well as low sell-side coverage, which we believe creates a promising area for active stock selection. Other factors are likely at play, but a quantitative process may be a great complement to fundamentally based strategies.
Bottom line
Shorter-term dynamics in interest-rate markets may already be reflected in market pricing. A broader lens of divergence may help investors find longer-term structural opportunities.
Equity Market Outlook
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Andrew Heiskell
Nicolas Wylenzek