This year’s market losses reflect rising prices and falling demand. But that’s not all. Investors also grapple with the unsettling feeling that they are now being gripped by entirely new and confusing economic, financial and political forces.
Much of the current market turmoil stems from a desperate longing for a return to “normal” and few signs that we will get there any time soon. Inflation may indeed stay higher for longer. Growth can remain sluggish. And headlines from Russia, China and the Middle East leave everyone unprepared for the geopolitical tensions to come.
From an economic perspective, the biggest changes can occur in trading patterns. The pandemic shock forced companies to carry higher inventories and look for alternative suppliers. Friend-shoring, according to the Joe Biden administration, may not require all gardening tools to be sourced from a NATO ally, nor will it mark the end of globalization. Still, prudent managers will want to maintain back-up stocks and identify additional suppliers in case of the next crisis. The tightening of sanctions against the world’s second largest oil producer has also triggered a massive restructuring of global energy markets. In particular, European trading patterns will feel the brunt.
Most important to the outlook, however, are inflation levels that look much more stable than textbooks are predicting. Central bankers are determined to protect their credibility, raising fears that the drug they are supplying today will have significant negative side effects well beyond next year.
We will eventually return to a world of lower rates supporting more demand again, but growth prospects look bleak for now. The tightening of monetary policy to combat inflation has also severely altered global financial flows as readily available money becomes tighter and balance sheets face prolonged stress.
Something always breaks in any tightening cycle, although it’s usually a part of the market that even professional investors don’t pay close attention to. Sometimes it’s Mexico, sometimes Orange County, sometimes Lehman Brothers. Distress in the UK pension system wasn’t on the radar just a few months ago, but financial disruption usually occurs where markets least expect it.
One can only guess what will come next. Bankers and finance officials gathered at the annual meetings of the World Bank and International Monetary Fund in Washington didn’t get far beyond the list of usual suspects in emerging markets. But developing countries with enough clout to disrupt global markets seem surprisingly resilient these days, with many raising rates early in anticipation of the stress.
The only thing we know for sure is that a prolonged period of a stronger dollar, rising interest rates and weaker growth will reveal weaknesses that will be difficult to predict.
Politically, rising tensions with China mean what was once the world’s greatest economic opportunity is now among its greatest sources of risk. Russia appears to be poised for a long period of isolation, although fresh waves of populism could test US and European unity in imposing sanctions. Meanwhile, Iranian demonstrations and a Saudi government testing the limits of US patience raise the prospect of a very different configuration of Middle East policy.
There can be a glimmer of hope and encouragement. Despite all the horrors on the Ukrainian battlefields and all the rising rhetoric in every exchange between Washington and Beijing, the world’s richest economies have shown remarkable cohesion. For all the talk of the US decline, the dollar’s strength reflects continued confidence in US institutions, and its reserve status appears to be durable despite geopolitical shifts.
Better alignment among the G7’s richest economies, however, reveals rising tensions with emerging economies in the G20, including not only Russia and China, but also onlookers like Saudi Arabia, Turkey and India. Businesses and investors should avoid being caught flat-footed amid these unfamiliar global dynamics.
Over time, investors could look back to this period as a time when fears peaked before more familiar economic, financial, and political patterns returned. For now, the evidence suggests we’re headed for something very different and confusing.
Christopher Smart is Chief Global Strategist and Head of the Barings Investment Institute.
The full version of this article was originally published here.