Geopolitics: Investing Amid Shifting Sands

Well, welcome back.

Let's take a look at some of these headlines.

Of course, we've all been seeing them-- from a controversial US election to Brazil's president being impeached to territorial disputes in the South China Sea.

These are just a few of the thousands of headlines that are crossing that you see every single day.

They're important stories that could have a real impact on many people's lives.

But just how do these events impact financial markets and, more importantly, your portfolio?

Here to connect the dots for us, Marko Papic.

He is a Chief Strategist with Geopolitical Strategy at BCA Research.

And he joins us from Montreal.

Marko, great to have you with us.

Thanks so much for taking the time.

We have you for two segments, one I'm kind of excited about.

I want to start off with just the obvious question.

I mean, we showed the headlines there.

Why should I care from my investment standpoint whether Trump or Clinton becomes the next US President or what's happening politically in Brazil and China?

Beyond the initial shock of something happen, why does it matter?

Well, first of all, it's a pleasure to be here.

And what I would say is that there's two ways to think about politics and geopolitics from an investment standpoint.

One is that every piece of news is, in some way, shape, or form, priced in by the market.

And quite often, because there's so much uncertainty associated with politics, it's usually priced-- there's a premium that's priced into an asset.

And in our experience at BCA, quite often, these premium are opportunity for investors, because they overstate the importance of some of the political events.

So the immediate event risk is usually overstated.

Now, on more of a longer term theme, I think it's very important to think about politics and geopolitics, because when you do connect the dots correctly, you could be in for a paradigm shift.

Take Brexit, for example, that you just discussed in the previous segment.

Brexit has had really very minimal impact on the markets, now a month after it happened.

Even the economic impact is being sort of debated.

But what it really signals is that the possibility of anti-establish electoral outcomes-- whether they're referenda, whether they're actual elections-- is perhaps higher than the probability that was priced in by the market.

And that really matters, because politicians will respond to that threat.

And we think they'll respond by, for example, increasing fiscal spending.

So there is a paradigm shift going on, and it's a political one, where we're exiting the sort of austerity era, austerity epoch.

And we're moving into one where the government is going to be quite more involved in the economy, whether that's through government spending, whether through regulation, whether it through boosting minimum wages.

And of course, that will have an investment impact.

So I would say that there's two ways to think about politics.

One is the event risk, which is quite often overstated.

The second one is more longer term, thinking about these paradigm shifts that are happening all around us at this point.

Fascinating stuff.

I want to talk about-- I mean, I'm probably more interested in these paradigm shifts you're talking about, because I mean, it has longer term implications for investors in terms of where they're looking.

But I want to bring up here a chart that you actually were talking to my producer about.

And I think this is a look at a potential Trump presidency, the probability, specifically, of him winning versus a 10-year yield of US Treasuries and the US dollar.

I've got this chart up.

Tell me why I care about this and what's interesting about this.

Well, I think what's interesting is that, after Brexit, we've had this situation.

So after the Brexit referendum in the UK, we've had equities do quite well.

But there's this conundrum, because as equities have been reaching new highs throughout the summer, at the same time, the tenure and really all the other developed government bonds have been plumbing some lows.

The yields have been doing-- they've been quite low.

Currently, the 10-year yield is at 1.58.

And so how do we square this?

How do we square the ongoing risk on environment with this sort of search for safety?

And one way that we've defined it is that it's just a general sense of unease.

Investors are uneasy about these out-of-consensus outcomes happening, whether it's in the UK with the Brexit referendum, whether that's with an anti-establishment candidate like Trump.

And I've made the argument with the chart and with other research that actually the current level of government yields-- so the 10-year yield-- doesn't really make sense based on economic variables.

It is a source of general unease with the ongoing paradigm shifts, one of which is this paradigm shift in which anti-establishment movements are doing really well and could have outcomes that investors are uncertain about.

So it's not anything specific.

It's not a risk where you can short something.

It's not like there's a coup in Turkey, and you're just going to go and short Turkish assets.

This is general unease, which is creating a tailwind for a safe haven asset, such as that 10-year Treasury bond.

OK.

I'm going to let people know.

I want to continue this discussion about paradigm shift.

I want to come back and see if I can get you to give me some investment perspective on this, because I know you're saying you're not on a specific investment call here.

But I'm sure there are some theories here.

But the paradigm shifts you talked about there, is anti-establishment sentiments that you're seeing.

Walk me through that a little bit.

So let's say that's true.

What impact is that having?

What are you seeing?

What could be the outcome of something like that?

Well, OK, let's think about it right now.

What is the one thing that most investors are certain about?

And you can look at that from a market pricing, from expectations.

It's that inflation is pretty much gone.

We're not going to have much of it for the next 5 to 10 years.

If you look at the yields, if you look at the inflation expectations, investors right now are pricing in that Japan and Europe won't have any inflation pickup in the next decade.

And even with the US, there's a lot of skepticism about the ability of the Feds to raise interest rates in this environment.

And what is this based on?

This is based on a very mathematical, arithmetic view of the world, which is that there's a lot of debt out.

There isn't enough demand.

We know this.

This is the result of the great recession.

And therefore, we are in a demand-deficient environment, which is deflationary, not inflationary.

So what's the investment relevance of anti-establishment movements?

Well, let's think about it.

What they're forcing politicians around the world to do, including in the UK after the Brexit referendum, is basically roll back austerity policies, focus more on fiscal spending.

I mean, look, Donald Trump and Hillary Clinton, they're throwing different plans and infrastructure spending at one another.

They're practically beating each other up with spending plans.

Then you have candidates on both sides of the ideological aisle in the United States talking about raising the minimum wage.

And then you, of course, have the anti-free trade rhetoric.

All three of those are on the margin inflationary.

So even while the high debt levels are arithmetically and mathematically deflationary, it's now politically unsustainable to continue with this low-growth deflationary environment.

And politicians are going to respond to that.

We have evidence of that in Japan, where the military has just asked for 5 trillion yen worth of more spending.

We have evidence of this in China, in Europe, and now in the United States as well.

And I think that's really important for investors.

Because if you're suddenly exiting the deflationary paradigm and entering an inflationary one, there's all sorts of investment implications, whether for gold, whether for real estate, whether for inflation-sensitive sectors.

It's a completely different world and one that we haven't been in for the last eight years.

I'm only going to have 30 seconds, but I want to just ask-- so I understand what you're saying, but are you saying then that this anti-establishment side is enough to trump to truly trump the low debt that's out there?

And I know these are just different ways of looking at it, but people-- I mean, it seems like that's a big rock to move, I would say, that the anti-establishment sentiment is enough to really kick start.

I know what you're saying-- fiscal, all that kind of stuff-- but do you think that will really move it?

Yeah, it could.

It could move it given the low expectations.

Everything is relative.

Fair enough.

And finance works on the margins.

OK.

Stay with us.

When we come back-- that was one of Marko's theories.

When we get back, we're going get a couple more, plus get his thoughts on what it means for repricing of some assets and what's interesting.

You're watching "Money Talk." We'll be right back.

We're back with Marko Papic.

He's a Chief Strategist at BCA Research.

He joins us from Montreal.

Fascinating discussion on the kinds of things you need to be looking at in geopolitics, what it means for your portfolio.

I know you have three primary market risks you're looking at, Marko.

And we talked about one, which I'm paraphrasing here is, I would say is anti-establishment sentiments, which could lead to more inflation, perhaps than what's being priced into the market right now.

Second one, I understand, is something called multipolarity.

What the heck is multipolarity?

It's just a fancy way of saying that nobody is in charge out there.

And that's it.

And it's really a concept from political science that tries to describe the distribution of power between states in international arena.

And the kind of a world we're living in right now, we're not used to.

And I think that's really important about all of these paradigms.

We're leaving two decades, three decades of sort of post-Cold War era, where we, as investors, didn't really have to care about politics or geopolitics.

There was a lot of consensuses out there.

There was a consensus on laissez-faire economics.

So that's what anti-establishment is breaking.

Now, another consensus was geopolitical.

And it had to do with the fact that the US was in charge.

And only really very few pariah states try to do anything about that.

And they were pretty much bombed on CNN live, right?

So that paradigm is shifting.

Now, more countries are becoming quite relevant and quite capable of pursuing their own foreign policy interests without really a say from the United States.

They don't really care what the United States says or wants to do.

And you're seeing this in a lot of different parts of the world.

One is in the Middle East, where, of course, we're all watching as a NATO member state and a nominal US ally Turkey is basically bombing and attacking a US ally-- very interesting development, one that you wouldn't have seen 10, 20, 30 years ago.

But what I'm really worried about is how this multipolarity, this lack of leadership globally is influencing East Asia.

Because here, you have South China Sea, which is a vital transportation network through which $5 trillion worth of trade moves.

And that's extremely vital for China, in particular.

And China is putting its footprint in the region and saying to all its neighbors, we're the first amongst equals, and you just have to deal with that.

And that's likely going to cause a number of incidents over the next year or maybe five years that could be market-moving, far more than anything going on in the Middle East or with Russia.

Each one of these points, you realize, is a two-hour show.

But I feel like I can't get into each one right now.

Right.

Let's talk a bit about anti-globalism.

That's another thing you're saying to watch out for.

Right.

So if you combine those two first ideas-- this erosion of laissez-faire capitalism as a sort of governing idea behind both emerging market economic governance or developing markets governance-- if you combine that with this multipolar world, what do you get?

Well, you get a world where every country is really out for itself.

And that's particularly the case in this sort of a low-demand environment that we're in.

Global trade hasn't grown faster than global GDP for 4 of 5 years now, which is extraordinary, because it only used to happen during global recessions.

So global trade is growing at a much slower pace.

And we believe that a number of very major economies are going to start looking at this low-growth, deflationary environment, and they're going to start saying, you know what, we'd like to guard our own slice of the global pie.

We want to protect our own slice, our own markets, and make sure that the proceeds from the consumption of our middle class go to our own companies.

And so it's going to be very tempting in this environment to start eroding globalization.

Again, on the margins-- I'm not talking about 1930s style collapse of global trade.

But we do expect more protectionism, more anti-globalization rhetoric seeping into the mainstream.

And I've been talking about that for a couple of years.

And it's already happened, especially with the US election, with the Trump campaign, with Hillary Clinton revoking the very free trade deal she herself penned as the Secretary of State.

But you're seeing that in other countries as well.

OK, Marko, I apologize, because I only have a minute left.

And I want to make sure I-- so given all that, you've got anti-establishment sentiments, you've got no one in charge of the world anymore, the multipolarity and anti-globalism.

When I take all that, what does that mean in terms of repricing of some assets out there that perhaps you think might be coming?

Well, I think first of all, large MNCs that depend on global trade are in for a tough time.

Profit margins are going to peak, and they're not going to get any better than this.

Second, emerging markets have benefited the most out of any area in the world from the globalized world and from laissez-faire capitalism spreading around the world.

I think they're in a lot of trouble.

And you're seeing that with the rise of populism in places like Turkey, South Africa, Brazil.

And finally, I think ultimately the current low levels of yields are pricing in nebulous risk, but they're ignoring the rising probability of inflation.

And that means that government bonds are probably not pricing correctly, the coming shift away from deflationary forces, which includes austerity and globalization.

15 seconds, any big winners here-- or not big winners, but the trend, perhaps would be reversing in things like, let's say, consumer stocks or financial stocks?

That's it.

I think you just hit it right there.

I mean, it's consumer stocks really-- anything that does with consumption.

People are going to have more money in the pocket, even though the economy might not have more money.

And that's because of redistribution, anti-establishment policies, and of course, curbing of globalization.

So what that means is that at least those on the lower income levels will have more money in the pocket.

And that should boost consumer stocks at the very least.

Fascinating discussion, Marko.

Such a pleasure.

I hope we get to talk to you again soon.

Absolutely.

Anytime.

Thank you.

Marko Papic, he is a Chief Strategist with Geopolitical Strategy with BCA Research.

And he joined us from Montreal.