Is your portfolio designed to weather the new geopolitical era?

A changing geopolitical landscape after four decades of relatively easy asset allocation

Peter Garnry

Peter Garnry

The difference between risk and uncertainty might sound subtle but it is not. Risk relates to things we can quantify based on a reasonable data sample size whereas uncertainty is about things that cannot be quantified. Geopolitical events are inherently about uncertainty and have a wide range of unknown outcomes.

The picture that is emerging from everything that has happened since Russia invaded Ukraine is that of a war economy, especially for Europe, with the natural outcome of fiscal expansion and likely persistent inflation.

Trade policies are part of a changing geopolitical landscape and the growing friction between Europe-US and China is also a source of uncertainty and inflation.

China’s intense export-driven economy means China is pursuing policies that are inconsistent with national security in Europe and the US. Predictably tariffs and industrial policy will increase in importance over time.

China’s intense export-driven economy also means that it is sensitive to foreign exchange levels against competitors and here the Japanese yen is obviously a key risk as explained by Charu Chanana, our head of FX strategy, in her note Chinese Yuan’s Double Whammy – Dollar Strength and Yen Weakness.

Maybe we are approaching a big reset in currency markets. South Korean policy makers made it clear today that the "excessive one-sided FX moves" would not be tolerated.

What should the investor consider in the portfolio to weather the future?

Asset allocation was easy in the past with 40 years of falling bond yields, a rather stable geopolitical landscape, positive demographics, no climate disasters and low inflation.

Going forward the clever investor will take the changing world into consideration. Could the investor not just be 100% in equities and then bet that history repeats itself?

Given the emerging picture of many structural breaks in our global economy across the factors described above, it would be too naïve to just do what worked since early 1980s.

These are some of the components investors should consider in their portfolio to strengthen it for a wide range of outcomes in the era of the war economy and severely negative demographic trends.

In essence the suggestions below deviate from the traditional 60/40 portfolio - 60% in equities and 40% in long-term bonds. We are not providing any portfolio weights to each category as each investor is different.

  • Equity themes: semiconductors/AI as this technology will be a determining factor for power in the future, defence because Europe has a significant deficit in military capabilities and new technologies to address drone swarms are necessary, cyber security because this is the new key operating system for any government and company and renewable energy because from a national security point of view, there is less risk due to no fueling source and the energy assets can be spread out in a decentralised way which is risk reducing by nature.

  • Equity sectors: in our quarterly outlook we say that the four most attractive sectors right now strategically (holding for the long-term) are health care, technology, financials and energy. These sectors have the best probability with the information we have today to deliver strong real rate returns over the next 10 years.

  • Gold: gold historically been a good risk diversifying component in times of war and inflation and the recent geopolitical period has once again proven that point.

  • Commodities: all the most severe inflation shocks in history have been associated with rapidly rising commodities, so an allocation to commodities make sense for the war economy and to hedge against inflation shocks. The green transformation could also trigger sustained trends in key commodities including copper.

  • Short-term and inflation protected bonds: with inflation stickier than estimated inflation protected bonds are worth considering as these bonds get their principal value increased in line with the official CPI Index. Short-term bonds create optionality and basically act like cash as the short-term bonds have little duration and are thus less risky under great inflation uncertainty.

Peter Garnry is head of equity strategy at Saxo Bank.

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