Geopolitics becoming a primary market driver for institutional investors

Global protectionism appears to be here for the long game. While investors may not want to start playing defence just yet, it might be time to start practicing again.

In it’s mid-year outlook, the BlackRock Investment Institute noted risk reduction, including elevating the levels of cash in a portfolio, would be a prudent measure given the muted global outlook for trade. Geopolitical tensions are creating uncertainty at a macro level, with the trade tiffs between the U.S. and China one of the most notable headwinds to growth.

Read: Canadian economy not immune to outside forces: report

Trade flows, industrial production, business spending and business confidence are all feeling the impact of these skirmishes, says Kurt Reiman, BlackRock Inc.’s chief investment strategist for Canada. “Where this has shown up the most in terms of financial market activity is in the pricing for more aggressive central bank action in order to stem the weakness in some of the data.”

Indeed, investors should pay close attention to the dovish tone central banks have pivoted to in recent weeks, noted the outlook. While markets are watching for signs that the current cycle is ending, this tone could push it further yet, allowing investors a little more time before the expansion phase begins to grind down.

“Instead of seven months ago when central banks were talking about gradually putting the foot on the break, or at least taking it off the accelerator, now it’s a little bit the reverse,” says Reiman. “They’ve shown their willingness to try to step in and provide some support in terms of easier financial conditions and perhaps also better borrowing conditions.

Read: How is fixed income faring amid renewed market volatility?

“This has shown up in the bond market, most importantly. We’ve had a really strong rally in bonds this year. The returns in fixed income could have been a halfway decent year for stocks. So it’s been quite positive.”

At the moment, BlackRock favours emerging market debt among fixed income assets.

Taking a wider lens, there may be room for the cycle to run, and institutional investors could use this opportunity to insulate against geopolitical tensions, the outlook said. Relative to recent years, markets have been experiencing far more volatility off the back of these constant tensions, notes Reiman. However, these tensions aren’t just creating the knee-jerk, but temporary, reaction they usually do within financial markets. What’s happening today is something quite different, changing geopolitics from one of several relevant market risks into a primary driver, he says.

“Historically, geopolitical risk doesn’t have a lasting effect on financial markets,” says Reiman. “When an event happens, there’s a downward move in riskier assets and an upward move in the price of safe havens. But then it fades, because it often doesn’t have an impact on the real economy. This is different. We’re seeing that the reversal of globalization and the impact it’s having on supply chain decisions and global value chains and companies’ ability to see their runway for growth is impairing business investment. It’s hitting trade flows. It’s having an impact on the real economy.”

Read: Uncertainty clouding institutional investor outlook: report

Fortunately, monetary policy and in some cases, fiscal policy, is coming to the rescue, he adds. “So in effect, these efforts are trying to offset the negative effects of these geopolitical tensions. But as a result, it is having a more lasting effect on financial markets. And that’s why it matters more for us.”