Q3 2018 Market Insights- Geopolitics take center stage


Geopolitics Take Center Stage

The quarter that was

The second quarter of 2018 saw headlines dominated by geopolitical concerns, which, after being largely discounted and ignored for most of 2017, are back in the forefront of the majority of investors and media outlets, bringing with it increased volatility in the markets. Despite the noise in the market commentary, North American equities posted positive quarters total returns, while the broad market outside of North America declined, with Emerging Markets leading the way. Part of the headwinds facing emerging market economies can be explained by a strengthening US dollar. The US Dollar Index rose by over 5% during the quarter, and in that line, we saw the Canadian dollar weaken from around $0.775 to $0.76.  


In the commodities complex, the major story has been the rise of crude oil, with WTI rising roughly $10 a barrel over the quarter, closing the quarter just north of $74. This lead to the energy sectors in both Canada and the US leading the charge, with the Canadian sector ETF XEG rising over 16%, and the US sector ETF rising 13%. Natural gas remains stuck below $3, and gold decreased below $1300.

What are we watching moving forward?

In our view, there are a few key themes we are watching that we feel will shape the markets for the rest of the year. In no order, these themes are the global growth story, political risk, the US dollar, and oil prices.

Is the global growth story intact?

With regards to global growth, our main question is two-fold. One, will US growth continue and two, will growth outside of the US continue to disappoint. In our view, the US growth story remains intact, unemployment is low, the labor markets are strong, and earnings estimates, while moderating, are still on pace to grow at a very strong rate this year. Foreign growth is going to continue to be driven by geopolitics, the direction of the US Dollar, and the direction of oil prices. As such, there are plenty of variables that will continue to shape the global growth story, but, if we see foreign growth recover along with sustained US growth, we would be back into a synchronized global growth environment that should be supportive of risk asset prices.

How does the threat of trade wars/geopolitics affect the market?

One major theme that poses a risk to global growth is the global geo-political risks that are rising. Now, while we feel that the majority of discussed geopolitical risk in today’s media age is noise and sensationalized to draw eyeballs and clicks, the fact remains that trade wars and escalation tensions between countries do and would have real world consequences and as such, is something we continue to monitor and evaluate seriously, by looking to steer clear or underweight specific industries that may be most affected by some of the proposed actions being taken and discussed. As an investor, we believe that one of the hardest things an investor needs to do is be able to ignore the noise and speculation and focus on the facts.

How does a strengthening US Dollar affect global markets?

Another important trend we feel will continue to shape the world is the question on the direction of the US Dollar. On one hand, the US economy is performing well, unemployment is low, the job market looks positioned to finally deliver long awaited wage growth, which would instill inflationary pressures into the economy, and prompt further tightening by the Fed. With the Fed hiking rates again in June and looking poised to raise another two times this year for four total, this could continue to be supportive of a strengthening US Dollar. However, a few of the tailwinds that helped the US Dollar move sharply may be subsiding, so we could see a scenario where the USD moves sideways or grinds lower. 

Where do oil prices go from here?

Finally, another major macro theme we are following pertains to oil prices globally. In this area, we can see two competing viewpoints emerging. The first viewpoint is that the US and Saudi Arabia are motivated to keep prices lower and the market in balance, to discourage excessive investment into the oil complex, leading to the over-supplied market that caused the oil price crash in 2014. The second viewpoint revolves around the fact that supply-side constraints and large reductions in global capex provide a compelling case for a floor around these prices and further upside potential in the price of oil. In the longer run, supply-side factors are more likely to be main driver of price movement, but in the short run, OPEC and Russia have enough market share to keep a ceiling on current prices, and seem motivated to do exactly that, as evidenced by the recent increase in output agreed to by the cartel and Russia.

Themes we like

A quick snapshot of major macro themes, sectors, and countries we currently are evaluating or continue to favor: Cybersecurity, India, Water, Infrastructure, Robotics & Artificial Intelligence, Agriculture, Financials, Global Energy. 


All data and/or charts are sourced to Thompson Reuters Eikon unless otherwise noted.
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