Thank you for listening to this podcast in today's episode, While 2022 turned out to be a nervous year, 2023 will continue to be troubling for investors. My guest, Elliot Heav of State Street Global Advisors isn't very optimistic about the upcoming year, both in geopolitical and macroeconomic terms. Enough reason for a conversation about the global market outlook and its implications for investors. My name is Maria Hun , and a very warm welcome to you Elliot.
Mariah. Thank you for having me ,
Elliot. Welcome. Again. Would you mind briefly sharing a bit more about yourself with our listeners?
Sure. I'm head of Global Macro Policy at State Street's Global Advisors. We are the world's third largest asset manager. And what I do is I look at thematic macro drivers that are relevant for investors, and they tend to be , uh, a combination of policy and impulses and macro responses. So policy in the broadest sense , uh, anything not only from the usual fiscal monetary side, but also geopolitics trade climate policy. And so I also serve as the company's chief geopolitical strategist.
Right. So chief geopolitical , uh, strategist that triggers me. Did did anything change in your role , uh, since the conflict between Russia , Ukraine?
Yes, my job security has gotten better. I Right . I am very busy these days, unsurprisingly.
So in the updated global market outlook of State Street Global Advisor, it says that 2023 will become or could become more problematic in terms of growth. Could you please explain that to us, Elliott?
Sure. Again, let's , let's, we should be cautious here. Uh , this is not the end, end of the world or anything like that. It is simply a growth recession, a global growth recession. We think all the major economies of the world are going to decelerate except for , uh, China, which is obviously coming out of a slowdown at some point. And we expect a reopening. Uh , so it's a downturn. It's not a , we think in terms of magnitude, the recession will be quite harsh in Europe and the uk.
We think it'll be very mild in the US and elsewhere too. We think it'll be more an average of the run of the mill.
Hmm . Now you're particularly concerned about the risk that the reopening fueled boom will give way to a bust induced by aggressive tightening. Why is that? Well,
I think it's , it's not a surprise. Anybody who's , uh, went shopping recently has seen the effects of inflation firsthand. Mm-hmm . , the re the reaction to inflation has been to tighten monetary policy. That means the cost of capital goes up, that starts to restrict credit. That starts to hit demand. And basically you get an economic , uh, downturn. And that's basically what we're happening, what's happening.
Uh , and so that's , uh, the usual stuff and that , that is necessary in order to bring inflation back down. Now, this inflation is a little bit different because it's largely driven , uh, by supply side , particularly in Europe. In the US it's more mixed. Uh , but at least even though it's supply side , you basically, central bankers can only affect demand. So the ideas bring demand down so that , so strongly that inflation numbers start to come down too.
Now, consumers, in , in many developed markets , uh, markets still sit on substantial excess , uh, savings. How is that going to help the economy, you think? Yeah,
You say substantial. I think , um, many of your listeners may think it's not that substantial. I mm-hmm. basically outside of the US that most of the savings pile is no longer that great. And particularly when I say no longer that great , I'm factoring in the really the coming months , uh, the higher energy bills. And so really by the time winter is over, you'll only have residual savings pile largely in the US and even in the US mainly among higher income Americans.
Now, that is does matter for consumption because higher income Americans have a higher share of consumption of the economy. But I would be wary of saying it's too much. Now, what it does mean is that it cushions some of the slowdown everywhere because yes, you're getting hit by higher prices, but at the same time, many consumers have some savings to afford higher prices. And so basically the, one of the reasons we think the recession in the US should be mm-hmm .
relatively mild, is because household balance sheets are very strong.
Right. And that's different to Europe.
That is different to Europe. Although again, yeah , policy should make some of the, the worst effects , uh, a little bit milder.
Mm-hmm . , how should investors deal with the prospect of , of slower growth colliding with sharply higher inflation?
Well, that's, that's, you're asking about the here and now, which is growth is coming down and we still have sharply higher inflation, but that's good to change. Next year, inflation will come down , uh, growth will bottom out and we'll actually get a bit of a reserve reversal.
So in the near term, obviously investors should need to stay , uh, conservatively positioned , uh, have a lot of cash or higher cash levels, maybe have some commodities to take advantage of those parts of the economy that benefit from inflation. Um , but at the same time, I would really advise investors to be ready , uh, to be ready to shift. Because as the cycle turns , uh, a lot of the things will, will change. For instance, a long duration bonds will suddenly become very attractive.
We think that's an interesting , uh, point. And then also even the more conventional , uh, risk assets as equities, there will be a nice entry point in the not to distant future. Uh , but not yet.
Not yet. And that's always the question, Right. When is that moment, and are you soon enough to, to react the end of the peace dividend could be slightly growth enhancing. Could you explain that to us?
Yes. Well, the end of the peace dividend means , uh, we, we move away from a world where, particularly in Europe, it , it didn't ma matter about spending money on defense. Uh , and a lot of that savings on defense actually went into social welfare, a variety of public expenditures now in the, for the recipients, that may feel like that's a better choice for , from a macro perspective, that's, that's always been a bit of a weakness.
So the peace dividend, who actually got it, Well, some recipients of welfare got a little bit more welfare beyond , and the big dividend went actually to , um, corporations who were able to , uh, enjoy slightly fit better tax regime with a much better, frankly, trading and market environment now . So some of the peace dividend when that unwinds will shift. Now you asked about the positive part, which is the growth enhancement.
Well, when we take money away or when we shift it from current expenditures that are just consumed, whether that's pensions, whether that's , um, any social support program, and we put it into cap capital expenditures, we invest it over time in , in generally such investments are lift productivity growth and therefore are growth enhancing. Uh , but it's not on day one, and it takes time. And in the process usually , uh, there's a lot of losers in that process.
And so that, that is actually a headwind for the economy. So the growth will come , uh, but it's not instant. Mm .
Um, we mentioned the war , uh, at the beginning of this interview. The Russia, Ukraine war is actually the third shock to the global economic order. In the past half decade following , uh, the Trump trade wars and the Covid pandemic, what impact has it had on the economy?
Well, I think most of the impact is obvious stagflation people have seen is high energy prices, high food prices , uh, and at the same time , uh, eroding growth. Um, but I think that the big impact is really, is that the whole talk and approach of de-globalization, which was maybe just a talking point , uh, has now really accelerated. You can feel the global trading and economic order starting to fragment.
And even if it doesn't tear apart, we don't go back to the Cold War , uh, but we do, What we do is global markets are smaller, certain countries get closed. Uh , certain sources of trade barriers get higher, certain sources of capital disappear. And all that means we're in a world that's less efficient , uh, less optimally allocated. Um, and , and that, that is a big shift for the global economy, which means basically we have a slightly weaker, worse performing global economy going forward.
It seems today that everything is being politicized. Uh, central banks are politicizing, inflation targeting is partly political. The introduction of the digital Euro dollar renminbi is political. And, and so is the energy transition as well. Has the economy become the puppet of geopolitical ambitions, would you say?
I , it's strange how you phrased that. I would, I would always say that it was never, it was never any different. It's just that the geopolitics, we had a very benign geopolitical cycle for 30 years. And so I think people have forgotten that, you know, geopolitics was a tailwind , uh, for un until probably the middle of the last.
It served as well for a long time. Exactly.
And , you know, obviously , uh, it was all, it was going great. We had the communist block dismantle liberalized their economies and joined the global economy. We had China and India , uh, adding to global labor supply and inclusion and global value chains . That's all been great. And now we're obviously at a different point in the geopolitical cycle, and it's, it's re returning to
It's not as nice .
Yeah . But it's always a driver. I mean, if you start from fundamentals, what's the backdrop? The big order geopolitically, what's the global economic order? And then you can kind of work your way down gradually to , uh, your own economy and market and business.
What we also see happening, the combined , uh, energy and agricultural price shock , uh, has in some cases the potential to be politically destabilizing. Um, what do you think we're gonna see from that Elliot ?
So to use metrics , uh, hard numbers, food price inflation has a different share in different economies. And where, where you'll see, it'll be most destabilizing in places where it's a high share of the consumer basket. And we've seen it, we've seen a default in Sri Lanka. We've seen problems in , uh, Pakistan and a variety of other emerging and frontier markets. Uh , those will , will carry on.
And frankly, that's a big worry for 2023 because it's not only food prices today, it's also the cost of fertilizers going up. So next year's crop, next year's crop will be more expensive as a result. And so that will carry on now in developed markets, it will just add to the general maez , uh, that the public is feeling. And so you, you can get, you could get more election volatility in demo democratic states.
And I , I think to some degree, Brazil is an interesting story that you , you can see it can , it can dr it enhances polarization in some ways mm-hmm . because it , it drives in other places, it could actually decrease polarization because you get a kind of a consensus building around inflation pressures.
Right. Um, the war , uh, Russia, Ukraine War, and also severe US let financial sanctions have raised doubts about the durability of the US dollar centric monetary order. What , what's your take on that, Elliot?
Um , my, my take is that we should do a dedicated bot podcast on that, but , I , I will summarize it ,
It merits its own topic. Yeah .
It's very poorly understood what upholds the US dollar, but in many ways, the capital financial flows that everybody's talking about, oh , US dollar century are a mirror of global trade flows. And until those change, the US dollar centric order remains intact. And so that, until you tell me that commodity producers are not going to run surpluses and China is not going to run a large surplus until then the US dollar rans supreme.
Okay. And let's agree to, to , to get back to that in a , in a separate podcast , um, the, the energy transition and also the adaptation to climate change are deeply intertwined , uh, with geopolitical competition. Does that give a cost for concern?
Why are you asking me questions that all deserve a separate podcast?
, uh, because I wanna make a series with you ,
I , I , I did a , a very in depth research project just on that one question last year mm-hmm . , and again, trying to pack it into 30 seconds. The answer is that it's, it's very destabilizing because leadership in the energy transition is tied up into leadership in digitization and other technologies.
So the geopolitics of , um, that we have of competition or tied into the geopolitics of energy and digital, and that's, that's a huge problem because what it is going to mean is you're going to get repeated disruptions and problems. So the supply shocks of covid , the supply shock of the Ukraine war, there's more to come in that space.
Elliot , we, we've discussed the global economy. We've looked at , uh, geopolitics. What are your top level or your key takeaways for investors?
Well, rates are moving higher, fast, and we live in a world of great uncertainties, so suddenly cash becomes more appealing. Uh , obviously you cannot have your portfolio vested in cash, but you know, cash is something that for 10, 12 years, we all avoided to have altogether. Like, Please don't give me cash. I need to , I need to do something with it. And that has changed, so that, that buys you some time , uh, uh, to , to , to make the tougher choices within.
Related to that, we , we still like commodities. They partially hedge for higher inflation, and particularly they're , they're not correlated with , uh, other financial markets in the way that bonds and stocks are now together. Within stocks, obviously relative value opportunities are a little bit more attractive. And as I mentioned, you know, the , this is not the end of the world. This is a downturn.
There are are still very cash positive, profitable companies that have quality , uh, characteristics that are , that remain attractive to hold or to , to , to buy into. And finally, again, if we do think the monetary cycles close to peaking, then suddenly a long duration bonds become very attractive. Again,
We're reaching the end of this podcast, but maybe we can finish , uh, the interview with a brief financial markets , uh, tour. And I'd like to ask you to briefly outline the opportunities for each asset class in in 2023, if that's okay. Um, let's start with the equities market. You believe an overweight to equities continues to be justified, right?
Yeah, we're, we're , we're still , we still have a slight overweight in equities overall in our portfolio , uh, for the reasons I just mentioned, which is that , uh, yes, there , there's a slow down and within the equity portfolio, that's where we've made a lot of changes, both in terms of geographical exposure and also in terms of the relative , uh, factors or characteristics that, that , that , that we think will perform better in this type of environment.
Hmm . And at the same time, you remain conservative with , uh, fixed income and are focused on, on timing to turn. What exactly does timing deter mean? I think we, I refer to it earlier, it's, it's either too late or or too soon.
Yeah. So the industry thing is , I , I mentioned long duration bonds for a while , and historically, basically the long, the , there's a peak in 10 year rates and longer, a few months before central banks actually reach the peak of the hiking cycle. I think historically, I think in the US the tenure is at , off the top of my mind, it's roughly three months prior.
And so if you think about that, where we are, it's November , um, we are clearly just months away from the Fed hitting the peak, which means that the, the rates on the longer end will peak very a few months earlier, perhaps even right now. And as there's an economic slowdown, those rates will decline, which makes obviously , uh, bonds, holding bonds at that end more attractive. So that's what timing the cycle is. We are , How could you get caught up ?
I think it's, it's a pretty easy trade right now. You could get caught out if for some reason inflation stays stickier and higher for longer. And I'll mention here that we are in the camp that really believes there's a big, big disinflationary wave about to show up on our shores that will bring down those numbers. Mm-hmm .
Elliot, you expect the structural bull market in commodities will continue to lead to elevated prices, right?
Yes. Uh , it's, I would be cautious though, if you commodities, I would separate energy and metals and within metals, I'd make big distinctions. We like commodities because even in energy, there's no reason for why prices should go down a lot. That does not mean we expect a multi-year supercycle, but we think prices will remain elevated in parts of the metals complex. We actually think there's a , a supercycle building, and so that will be with us probably four or half or maybe a full decade.
Uh , and so overall the commodities complex as a whole is a nice hedge against high inflation. And again, it's not, it's one of the few areas of low correlation these days , uh, with , uh, the , with other risk assets. So we find it has holds great appeal.
Okay. Um, now lastly, you believe that many emerging market countries are in a decent position to weather a world of title liquidity and increased uncertainty. Um, could you tell us what countries we are talking about?
Yeah, it's been hard to be excited about emerging markets, and the reality is since early 2020, I've, I've not liked that asset class because of all the problems that that come with it. The advantage this time is that the structural weaknesses are better. So current account deficits , um, and so forth are, are smaller than they have been the past. The second thing is that these central banks, they did not wait until 2022 to get get started. They've actually been tightening all through 2021.
And so you actually there in many cases, we already have , uh, rates coming down quite rapidly in , and finally for some emerging markets, particularly ones that we were unloved, the war has been a blessing. You know, a lot of them are are net food exporters or net energy exporters. And so you've had had a , a positive terms of trade shock in, in parts of the emerging market .
So that's particularly Latin America , uh, which I really was out of favor for many years and for good reason , uh, whether that's now even geopolitically, a country like Mexico is benefiting from the world around it. And that goes for a few of the other countries. Obviously, domestic policy choices matter. Um , and otherwise at parts of Southeast Asia also look relatively good , uh, from an EM perspective.
Thank you. We'll wrap it up with that. Uh , Elliot , thank you so much , uh, for being here with me and for talking about the global outlook. Um, and I would say hope to welcome you back and , and talk more about the , uh, the items that , uh, you said you had so much more to share on. So thank you for being here. My pleasure. I would like to thank today's guest, Elliot Heav for his global outlook. This podcast is offered to you by State Street Global Advisors.
It was recorded as part of his series dedicated to the Outlook event of investment officer. For more podcasts, please visit investment officer dot anell slash podcasts. And if you'd like to know more about State Street Global Advisors, please visit ssga.com/nl .