The Inside View Summary - Markets in Motion: Shifts Transforming Economies and Markets

Markets in Motion: Shifts Transforming Economies and Markets

Understanding the structural shifts in today’s rapidly evolving economic landscape is critical for long-term portfolio success. We believe the totality of these shifts have ushed in a new regime. Investors today are operating in an environment of higher interest rates, increased inflation and more variable economic growth. Alongside disrupted trade relationships and expansionary fiscal policies, investors are facing a unique economic and market environment that is creating a more complex investment landscape that may also offer opportunities to position portfolios for success in the next regime. For asset allocators, understanding what you own and why you own it is more important than ever.

It’s important to first define a regime shift, which we see as a significant, structural, and secular change in how economies and markets operate. This does not mean the principles of economics and markets no longer apply, rather that prior trends have abruptly shifted and as a result, may require investors to rethink how they structure their asset allocations on a going forward basis. Notable historical examples of regime shifts include the Bretton Woods agreement in 1944, delinking from the gold standard in 1971 and China’s ascension to the World Trade Organization in the early 2000s. While the “pre-covid” regime was characterized by low interest rates, low inflation, modest economic growth, and a relatively stable global trade system, today’s environment features higher rates, higher inflation, less consistent growth, and a major rewiring of global trade relationships.

In this webcast, we explore, tariffs, the US-China relationship, reindustrialization, AI and implications for asset allocation.

Tariffs

Equity and credit markets have largely looked through any negative impact from tariffs with equity markets reaching all-time highs and spreads near cycle lows. So why have markets shrugged off tariff concerns?  While evident to most, the math behind tariffs is sometimes misunderstood and often misreported in the mainstream media. Tariffs are applied to the wholesale price of goods imported rather than retail prices that consumers pay, which means that a 10 percent tariff, even if entirely passed onto the consumer, will impact retail prices by far less than 10 percent. Companies may also choose to absorb the higher costs or at least a portion of them. In addition, companies can recalibrate supply chains to adapt to tariffs to further reduce the overall effect on consumer prices. Markets seem confident tariffs will not cause the economic calamity that was initially feared.

US-China Relationship 

Ongoing trade tensions and tariff negotiations between major economies can have long-term implications for investors and global supply chains. Considering the size and economic positioning of supply chains in China’s economy, there has been significant focus on where tariff and non-tariff negotiations will settle between the US China. While tariff rate negotiations have captured the headlines, we believe it’s more appropriate to recognize that the US-China relationship is in a long-term renegotiation of how the world’s two largest economies will interact. Some of these tensions are driven by a system-level of competition between China’s centralized economy and the US’s decentralized ones where inherent conflicts, such as Chinese state-owned enterprises benefiting from zero cost of capital, contrasts with the market-driven cost of capital in the US. This polarization has become increasingly evident in recent years. A constructive dialogue between the two nations is essential for coexistence given current levels of cross-dependency.

Reindustrialization

Another key feature in this new regime is the expectation of reindustrialization with potential for real economic growth through more domestic manufacturing by countries that had previously deindustrialized. Factories that initially moved overseas to take advantage of cheap labor have now modernized, creating opportunities for skilled workforces to manage advanced robotics as these operations are reshored. While the US is a focal point for reindustrialization there are also opportunities for other countries and regions of the world that have also experienced deindustrialization such as Japan and certain countries in Europe.

Artificial Intelligence 

Rapid advancements in technology and AI have not only supported equity market optimism recently but has also resulted in the further concentration in US equity indices considering that AI industry leaders are largely based in the US. While AI has the potential for significant productivity gains, the build out of capacity will require high levels of investment in fixed assets and technology companies may become more like capital goods companies with more volatile cash flows as capital expenditure requirements to remain competitive rise.

Implications for Asset Allocation 

With these key factors in mind, we believe the alpha component of asset returns will become increasingly important as investors navigate macroeconomic changes.

We see particularly attractive opportunities in the following areas: 

• International developed and emerging equities offer good relative value and opportunity for profit margin expansion. 
• US small and mid-cap companies, which are more domestically focused than large caps, present interesting opportunities as reindustrialization takes place 
• Fixed income now offers meaningful yield across asset categories, but investor expectations should be on the carry rather than capital appreciation from significant rate declines at the longer end of the curve. 

Looking Ahead 

We believe the current market environment favors alpha generation through stock picking rather than relying on broad market gains. Active management through stock selection, and a deep understanding of fundamental, macroeconomic and geopolitical dynamics will continue to be crucial for navigating this complex investment environment. 

The views expressed are those of the speaker and are subject to change at any time. These views are for informational purposes only and should not be relied on as a recommendation to purchase any security or as an offer of securities or investment advice. No forecast can be guaranteed. Past performance is no guarantee of future results.