The U.S. killing of a top Iranian military leader and the subsequent retaliation by Iran in recent weeks marked an escalation in U.S.-Iran tensions. This reminds us of still heightened geopolitical risks across many dimensions, even as we see a relatively benign backdrop for risk assets in 2020. The U.S.-China trade conflict – the dominant geopolitical risk in 2019 – has paused, yet we expect enduring strategic rivalry between the two countries, especially in technology. We see U.S. Treasuries as a key source of portfolio ballast against potential risk selloffs.
The market’s overall attention to global geopolitical risks sits at elevated levels, as proxied by our BlackRock Geopolitical Risk Indicator (BGRI). See the chart above. Our BGRI measures the attention to top 10 risks in analyst reports, social and financial media, and has risen to high levels in recent years. We had raised the likelihood of growing Gulf tensions late last year, and still see ongoing and heightened tensions despite the avoidance of major confrontation between the U.S. and Iran. The market reaction to date to Gulf tensions has been muted, partly reflecting the decreasing heft of the Middle East in determining global oil prices, with the U.S. now a net oil exporter. Yet a sustained escalation that results in repeated attacks on oil facilities or disruptions to shipping in the Persian Gulf – more materially threatening global growth – would likely change this story.
We see a relatively benign backdrop for risk assets in 2020, with easier financial conditions supporting a growth uptick. Read details in our 2020 Global Outlook. A key underpinning assumption is that global trade tensions move sideways this year. Recent developments in this area have been positive for markets: U.S.-China trade tensions appear to be going sideways, and the U.S.-Mexico-Canada Agreement on trade looks set to pass the U.S. Congress soon. Yet any broader surge in geopolitical risks in the Middle East or elsewhere could undermine the sentiment in – and the performance of – risk assets. What other geopolitical risks should we look out for in 2020? Below we detail three broad dimensions.
First: We are seeing fragmentation at a global level across a range of dimensions, including ideology, trade and technology. Technology decoupling between the U.S. and China is underway and will force countries and businesses to navigate this evolving landscape. We expect such tensions to persist even after a limited “Phase 1” trade deal that may temporarily defuse U.S.-China trade tensions. Domestically, political polarization is reaching a high point in many countries. The U.S., for example, faces a contentious presidential election with the potential for starkly divergent policy outcomes. We have downgraded U.S. equities to neutral on a tactical basis amid rising election uncertainty. The second is an increase in global protests, partly fueled by rising income and wealth inequality and facilitated by social media. Many governments are ill-equipped to respond. With limited monetary and fiscal maneuvering room, this could lead to further unrest in any downturn.
The third is cybersecurity. Tensions are elevated between the U.S. and many adversaries such as Iran and North Korea, which have the capability to mount attacks on critical infrastructure and institutions. An uptick of “ransomware” attacks against cities and states with relatively poor defenses may be a sign of things to come. Markets look to be complacent about such risks: the attention to cyber attacks has been on a steady decline since late 2017, our BGRI shows. U.S. Treasuries and their inflation-protected peers have done well to cushion portfolios against recent risk selloffs – and we prefer them in both tactical and strategic portfolios. Government bonds in Europe and Japan have diminished ability to serve such as role as their yields near lower bounds.
Read more market insights in our Weekly commentary.