Beware of financial wildfires in a global heatwave: Mike Dolan
The world economy has not been cooled by two wars or sky-high oil prices. Asset managers are forced to stay invested despite the hot global growth in the second half of this year. Higher interest rates could be the only remaining policy brake.
Since the Iran War - which pushed crude oil prices 50% higher, and natural gas doubled - there has been a nervous waiting to see the ripple effects on the global economy. As the third quarter comes to an end, global activity appears?to be picking up speed, if not accelerating, due more than anything else to an AI race, and corporate investment boom.
This combination of a strong economy, a hot geopolitical climate, and supply disruptions is the reason why inflation rates continue to rise.
In the last week, we have seen some very impressive numbers. One example was the unexpected rise in U.S. employment in August. The Eurozone and Japanese GDPs for the second quarter have both been revised upwards. China's export and import growth has been running between 25-30% per month. We've just finished a corporate earning season with the fastest aggregate profit increases on record.
Copper prices, often viewed as a barometer for global industrial activity, are once again rising to record levels and have nearly doubled in just five years. Other factors are also affecting the price of copper, such as U.S. Tariff fears and supply bottlenecks. It is still a reflection of the booming economy and the copper demand, as well as the rapid buildout of AI data centers across the globe and increased defence spending.
The same conclusion is reached when measuring global business sentiment.
JPMorgan's world business surveys, which include manufacturing and service industries, show that the global output index increased in August for the fifth consecutive month. It was at its highest level in over two years. This is in line with the bank's estimate that global GDP could grow by 3.1% annually, which is higher than its 2.3% global potential. It said that a rise in new orders, future output components, and firming production are all positive signals.
"Excluding recessions, the August reading is in line with peaks of mid-expansion upswings during the last two decades."
The strength of this upswing is undeniable, even though it may be dangerous due to its impact on the debt market and inflation. There's no sign that the AI and defence investments will slow down next year. The International Monetary Fund is also likely to upgrade its estimate of world growth for 2026, from the 3,0% penciled in during July. The IMF's estimate for 2027 is also likely to be revised upwards from the 3.0% it penciled in during July.
In addition, while governments increasingly rely on growth to curb the rising debt-to GDP ratios, they do not seem to be willing to slam on fiscal brakes. This leaves the central banks as the only remaining policy constraint.
NORMALIZING DISRUPTIONS
The current investment debate revolves around how portfolio investors can continue to ride this growth, and how they should react to the parallel rise of long-term lending costs that has reached their highest level in decades.
Some people believe that the decade following the 2008 banking crisis was a peculiar time in post-WWII history: a period of low investment and growth, with high savings, and subdued prices. This was not merely an aberration but reflected 'a new normal' based on ageing demographics.
Jim Reid, a strategist at Deutsche Bank, says that rising bond yields are likely to refocus investors' attention on the coupon portion of the bond proposition and not the capital gain (or loss) aspect.
In an opinion piece published in the Financial Times on Tuesday, he said that "Bonds are now bonds again" and we're seeing a "continuation from the long normalisation since the "historic anomaly" of the 2010s.
The current geopolitical turmoil, supply shocks and growth, as well as the financial booms and crashes of pre-2008 may seem to be a repeat of the Cold War, Vietnam and Middle East oil embargoes.
David Kelly, JPMorgan Asset Management's chief global strategist, believes that the current period is different than the previous decade as well as the old norm and calls it "the new, new normal."
Kelly writes that investors should recognize the similarities and differences between today and the 2010s, such as the ageing population, the rising inequality and the ebbing dollar.
He also highlighted unique elements of this new phase, due to the return of economic nationalalism and trade protectionionism, unprecedented since World War Two as well as the potential productivity-boosting AI transformation.
We will not return to the old norms in terms of the amount of debt that governments have accumulated, both to protect economies from pandemics and to stop the economic slump from turning into a deep depression. Kelly believes that this will change the game for investors in the future.
He wrote: "We cannot expect Treasuries will rally in response to an economic or a market?downturn in the same degree as they did during the old normal." Investors must diversify their portfolios.
The word "normal" is not the best way to describe our world today.
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(source: Reuters)
