The war in Ukraine and resulting sanctions are accelerating the formation of two broad alliance camps – one defined by autocrats and one by democratic nations. Russia’s invasion of Ukraine has strengthened the solidarity of democratic countries and, similarly, states with autocratic leadership (with China and Russia at the core) are also being driven closer together. Over time, the two alliance camps of autocrats and democrats will continue to coalesce and integrate more closely within themselves, while decoupling from the other. This is likely to have profound implications for investors.
1) ‘Statism’ trumps globalism
A world with permanently high geopolitical competition, independent economic blocs and rival security alliances means that governments will need to invest strongly in their own economies to enhance their resilience and national security. This will require large levels of state-led investment, and we are already seeing this take shape: the US Congress is close to passing a bill to fund and implement the US CHIPS (Creating Helpful Incentives to Produce Semiconductors) Act for onshoring semiconductor plants, and Germany recently announced a €100bn defence fund. A shift towards state-led investment will favour capital-intensive sectors such as energy, utilities, industrials, defence, and technology hardware. By contrast, sectors that thrived during an epoch of unconstrained globalisation could face headwinds.
2) Elevated and volatile inflation persists
The last 40 years of globalisation have been accompanied by an almost constant decline in inflation which has allowed central banks to cut interest rates to ever-lower structural levels. The geopolitical backdrop is now calling for a realignment of supply chains within the respective blocs of democratic and autocratic countries. In aggregate, high levels of domestic investment compounded by already tight labour markets could prove to be inflationary over the long term and may necessitate higher neutral levels of interest rates. During the realignment phase, periodic supply shocks driven by disputes and conflict are to be expected. Even if central banks are able to subdue the current inflation spike, structural forces mean they might struggle to keep inflation suppressed.
3) Global currency system to be redefined
It is clear that the US wields enormous economic power through its control of the global financial system, owing to its currency hegemony and the ability to stop non-compliant states accessing and using its financial system. In a bipolar system in which autocratic states live in fear of the US financial system and its dollar weaponisation through sanctions, it is logical they would wish to hedge their options or move away from the dollar system altogether. It is, however, impossible to predict at this point in time what a new global currency order will look like.
4) Commodities and climate
How will the world tackle climate change without cooperation between the democratic and autocratic alliances? Without access to some of the raw-material inputs required for energy transition from Russia or other Eurasian countries, it will make the achievement of climate targets more challenging. Ultimately, energy transition is consistent with higher levels of national security, and therefore we remain optimistic that policy is headed in this direction. In the short term, the energy-supply shortage will put the emphasis back on the importance of fossil fuels in meeting economic needs. Governments will need to factor geopolitics into a more pragmatic energy-transition policy, and investors may wish to accommodate both fossil fuels and clean energies in portfolios.
A changing opportunity set
In these challenging market conditions, many DC schemes will be evaluating how they can continue to deliver the best outcomes. We believe such situations highlight the benefits of an active and flexible investment approach, with the ability to take advantage of a changing opportunity set, underpinned by a sound risk-management framework that incorporates environmental, social and governance (ESG) analysis.
This is a financial promotion. These opinions should not be construed as investment or other advice and are subject to change. This material is for information purposes only. This material is for professional investors only. Any reference to a specific security, country or sector should not be construed as a recommendation to buy or sell investments in those securities, countries or sectors.
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