One of the biggest, trillionaire investment firms is getting nervous. Somethings are in our control, like frothy equity markets. Others are not. Don't like valuations in the S&P? Buy bonds, or look for value elsewhere, like in emerging markets. Don't like bonds? Buy dividend blue chips, or heck if you're that much of a scaredy-cat just put the money in a savings account, gold or buy real estate, for crying out loud.
Beyond credit risks and runaway bulls, BlackRock has 10 global risks keeping their fund managers up at night. And unlike positioning portfolios based on factors like momentum or value, geopolitical risks is hard to factor in.
Here are the top 10, with a brief description summarized from the September BlackRock Investment Institute report. These three, in particular, generate the coldest sweat from BlackRock asset allocators.
1.NAFTA dies.
The fourth round of NAFTA talks ended this month, with Mexico and Canada rejecting Trump's proposals. This is quite possibly the beginning of the worst case scenario playing out. However, news reports have suggested once again that there's been progress on less contentious parts of the deal. This has been the hallmark of the Trump Administration to date. Trump-related headlines are horrible, then they are bad, then there is a sort of purgatory, then they look ok, even promising, and then they get ugly again. Negotiations aren’t over. The next round of talks takes place in Mexico City in November.
"Our base case is that successful negotiations will be completed in early 2018," says Isabelle Mateos y Lago, BlackRock's chief multi-asset strategist. She admits that her hopes have recently diminished given tough positions from U.S. negotiators. Uncertainty is back. "Market risks are biased to the downside given that a good outcome is priced in, in both Canadian and Mexican markets," she says. Worth remembering, next year is an election year in Mexico. Their government will have other things to worry about and if a deal is not signed early next year, NAFTA could be in limbo for all of 2018. Depending on how you look at it, that might not be a bad thing.
2. Kim gets crazier.
Every other day there is a new headline warning us of the dangers of North Korea. At this point, you can just make up headlines like these: Kim To Unleash 'Hellfire' On The U.S.; Kim Ready For War!; Kim Vows To Destroy Trump's America; Kim Shoots Off Mouth And Two (Dud) Missiles.
North Korea is the boy-that-cried-wolf nation. In the best case scenario, it keeps crying wolf. There is a worst case.
"The possibility of armed conflict has risen, given North Korea’s missile launches over Japan, a nuclear test and an intense war of words. This has raised the chance of misstep or miscalculation," says Lago. She's not forecasting a war, or even a nuclear explosion just yet. But thinks the crisis strains U.S.-China relations just as trade tensions are rising. Which brings us to No. 3 on the BlackRock's Halloween fright list.
3. A Chinese trade war!
“The U.S. and China are drifting toward greater tensions because of increased economic competition and the inevitable friction of a rising power challenging an established one,” says Tom Donilon, chairman of the BlackRock Investment Institute.
BlackRock strategists see trade and market access disputes straining the relationship in the long run and think markets have yet to price this in. The two major China ETFs -- tickers MCHI and FXI -- are all outperforming the MSCI Emerging Markets Index.
In the short term, tensions could rise if Chinese President Xi Jinping pursues an even more nationalistic agenda in the wake of the National People's Congress, Donilon wrote in last month's report. (Hint: Xi did that yesterday.)
U.S. military action against North Korea and/or an accidental clash in the South China Sea would deal a blow to the relationship, report authors wrote, and hurt global risk assets. Their base case is that the U.S. and China avoid serious conflict in the near-term, and use President Trump’s upcoming visit to China to throw some water on the fire.
Judging by Trump's rhetoric, here's a prediction: "Xi is a wonderful man, a greater leader, love China. Love the Chinese. But we gotta do something about these subsidies that are hurting the American people."
Price that in.
Those three scenarios are the riskiest in BlackRock's view.
The bottom seven are more regional in scope, impacting smaller markets like Spain or Austria, but with the possibility of being a geopolitical event that leads to a sell-off in risk assets. The following seven events are not listed in any particular order. BlackRock did not give further explanations as to what these risks might mean for the markets, so I am doing it myself.
4. Major terrorist attack.
With ISIS on the run and Al Qaeda not much different, small, targeted attacks are more likely than not. In Europe, where some radical Muslims have turned on the locals and taken them out in knife attacks, concert hall bombings, and gunfire, a continued problem with renegade individuals will push European voters to the right on immigration policy. Nationalist, anti-open borders politicians are already gaining power in Germany, Austria, and the Czech Republic. In Europe, some call it an anti-establishment wave. To some extent, that is true. But what is more likely to be true is that voters are rejecting Brussels and Berlin's open borders policy and want a say in who they take into their countries. More terrorist attacks will not help the establishment way of thinking about Europe.
5. Major cyber attack.
Blame Russia? Why not. A cyber attack on U.S. infrastructure or a cyber attack that targets next year's elections in Russia (revenge?) could be cause for more animosity between Washington and the Kremlin. There will be speculation and the requisite whodunnit mystery, never to be truly solved. If heated, it would lead to more sanctions and could test European allegiances to the United States. Russia is one of the EU's most important markets and it is reliant on Russia as a key source of natural gas.
6. Russia-NATO conflict.
Any conflict would be waged through proxies. Russia is not in conflict with any NATO countries, though NATO institutions have sounded alarms about Russian troops on the Baltics. The only proxy conflict possible at this time is in Syria and Ukraine. Syria would be the worst. If the U.S. were to promote regime change in Syria by doubling down on support for anti-Assad forces, we could see the Syria crisis worsen. Russia is supporting Syrian President Bashar Assad. Congress has called out Russia for its support of Assad, so if there was a flare up it is not unreasonable to believe that the Treasury Department would move to strangle the Kremlin by banning the purchase of Russian government bonds, and the securities of corporations already targeted by sanctions. The recent sanctions law requested Treasury, State and the Director of National Intelligence office to review the possibility of sanctioning those securities. This would be a negative for VanEck Global's Russia ETF (RSX).
7. South China Sea conflict.
China wants more water rights. The U.S. doesn't want them to have it. Nor does Japan (of course). In the chessboard game of global armies and navies, China is winning this one. Southeast Asians would have to more broadly view China in a negative light before they picked Team America. Given the amount of economic influence China now has in that region, it is unlikely that any government there would come out as overtly anti-China. The probability of this developing into a serious stand-off is low.
8. Escalation of conflict in Syria and Iraq.
Both of these countries will have a marginal effect on oil prices. OPEC no longer dictates the direction of oil. Russia and the U.S. do. At this point, no one expects anything but war and bloodshed in Syria and Iraq. Peace would be a surprise.
9. Fragmentation of Europe.
See number four. Terrorist attacks committed by Muslims, including Muslim citizens of European nations, will accelerate a process already underway. How far it goes is anybody's guess. Spain is set to remove the autonomous charter of Catalonia, the state known for Barcelona, Las Ramblas, and the biggest independence movement in the eurozone. One cannot discount similar attempts at greater autonomy, and ballot box mini-revolts against a leadership being blamed for a failed immigration policy and austerity in peripheral Europe.
10. Sunni vs Shia.
Saudis versus the Iranians. This could escalate depending on which way the wind blows in Trump's other 'repeal and replace' -- the Iran nuclear deal. Oil prices would only be affected if the Saudis and Iranians really went at it with loaded guns and fighter planes.
Overall, BlackRock strategists think that long-term government bonds are the best way to hedge against risk and protect from equity market selloffs. If any of the top three risks came to fruition, this market goes south in a hurry.
