Three pressing questions keeping investors up at night

Recession worries, geopolitics, and the U.S. election

2024 is proving to be another year full of surprises. Investors have been bracing for recession risk, political uncertainty, and the usual seasonal weakness heading into the final stretch. Instead, what they got was a jumbo Fed cut, bazooka-style stimulus from Beijing, and a full-blown risk-on rally in the third quarter. Who had any of that on their bingo card?

But it was always going to unfold in a bumpy way. Investors are still navigating an economy adjusting to the shock of the largest public-to-private wealth transfer in history. These latest surprises, rather than signaling an inflection point, simply extend a long narrative: The post-pandemic cycle has been unlike any recent ones, breaking the reliability of traditional economic forecasting indicators. And it continues to do so. Take your pick from recession signals that turned out to be false alarms: inverted yield curves; aggressive rate hikes; manufacturing slumps; regional bank collapses; declining leading indicators; and for the most hardcore macro geeks, the triggered Sahm rule. Textbook macro remains stuck in a bear market.

Meanwhile, the world is awash in new realities. Macro faultlines marble the entire globe. Forget about risks from fragmentation and rising protectionism, the three major economic blocs that can meaningfully move global growth are each grappling with their own internal challenges.

In America, the public is fixated on what may be the most divisive presidential election in history, with an outcome that will hinge on a handful of voters in half a dozen states – and whose result is liable to be contested.

Across the Atlantic, the Eurozone has lost access to its most important supplier of cheap energy and faces numerous other frailties, including the existential risk of becoming little more than an industrial museum (Mario Draghi, former ECB president, devotes 393 pages of sober reading in a recent report to this topic: see “Future Of European Competitiveness”).

And then there’s China, where policymakers, apparently long content to do the bare minimum to support domestic growth, have finally signaled a major policy U-turn – and hardly anyone is buying it.

All of this has forged an easy fraternity for those predicting more macro doom. Global pessimism, as it has been in recent years, remains elevated. Investors have taken notice of the chaotic conditions, with our inbox overflowing with questions over the last month. The Forstrong team has also been busy engaging with many of our individual investors and institutional clients (while also recording podcasts from China, launching a new ETF on the Toronto Stock Exchange, and hosting our regular global investment roundtables in various cities). Below, we tackle the five most pressing questions we’ve received, aiming to help macro-minded investors make sense of the unfolding landscape and stay on track with their longer-term objectives.

Here are the first three. I’ll post our replies to the remaining two in my next article.

Question 1: Where’s the recession?

I’m confused about where we are in the economic cycle. Shouldn’t we be in recession by now?

Many investors have been thrown off over the last few years by pandemic distortions, fruitlessly attempting to apply a traditional market-driven business cycle framework to current conditions. It has been anything but that. Today, most investors are framing economic conditions as “late cycle.” But are they really? If anything, we have already had recessionary conditions over the past two years in key segments of the economy like housing and durable goods.

What’s more, sharp economic slowdowns occur when households and businesses get caught too far out on the risk curve and are forced to cut back quickly, triggering a self-reinforcing dynamic and a reflexive recessionary process. How do we get a recession when the world has spent the last 24 months hunkering down for a downturn that never came? It’s hard to get hurt jumping from a basement window.

Looking ahead, the recovery that started in the U.S. is now spreading globally. Economic activity is firming, the cost of capital is falling, and many global markets, left behind over the last few years, are quietly gaining momentum. Most importantly, corporate earnings, especially outside of America, are finally turning up. In short, the data – dare we say – increasingly points to an “early cycle” environment. Or, using the popular airplane analogy (since it seems to be the most common metaphor), the no-landing or even lift-off scenario remains the one investors should tilt asset mix toward. That means higher-than-average risk through pro-cyclical equity overweights, short fixed-income duration, and a generous allocation to international assets.

Question 2: Shocks and fragmentation

We seem to be getting more geopolitical shocks lately and “fragmentation” seems to be the buzzword. How should investors respond to this?

At a time when nearly every newsfeed reveals the world to be a dark place — whether by war in Ukraine, the Middle East or looming threats in geopolitical hotspots — many investors are running for the hills. Global money market funds have continued to swell and the investment newsletter business has been busy preying on the fear (you know who you are). But the first rule of investing is to never prepare for the end of the world: it only comes once and, when it does, nothing really matters anyway.

What does matter for investors? Timing geopolitical threats is speculative at best. But the grand canvas of geopolitics is changing and investors should recognize that the globalizing impulse that has defined the world economy for over two decades is now in rapid flux. New economic barriers between countries are choking the free and frictionless trade that once flowed across national borders. Yet, for all the hand-wringing about fragmentation, the world is not so much “de-globalizing” as it is reorganizing into regional blocs. Supply chains are increasingly centred around three major hubs — China, the EU and America. Emerging markets ex-China are also trading more with the rich world than ever before, but they have also added a huge amount of trade with China and each other. Despite the rhetoric, overall global trade has continued to rise.

This trend raises big questions. Are these developments commodity and capex intensive? Without a doubt. New supply chains will require rebuilding new industrial infrastructure. Will there be winners and losers? Yes. Rising protectionism is largely a Western phenomenon, and tariffs benefit those not caught up in them. For instance, China’s current excess industrial capacity, which was a huge deflationary force upon the world in the 2000s, will now only provide disinflationary tailwinds to nations not involved in tariff disputes with the West.

Finally, are investors prepared for this shift? Hardly. The dominant trend over the last few years has been a rush into cash and fixed income. But if we’re entering a longer-term inflationary period, marked by conflict, fragmentation, and supply shocks (rather than the demand-driven downturns over the last few decades), then developed market bonds won’t stabilize portfolios as they once did. Instead, they’ll amplify volatility. The diversifiers that investors will need are inflation rather than deflation hedges.

Question 3: The U.S. presidential election

The upcoming U.S. presidential election seems like a major market risk. What should I know heading into November 5th?

Despite dramatic headlines, presidential elections have historically shown very weak actionable trends for markets. While profound differences exist between Trump’s populist, deregulation-focused agenda and Harris’ progressive stance on social justice, climate action, and economic equity, the U.S. political system limits presidential power without congressional support. Every president since 1980 has faced a divided government. Gridlock again is the most likely result.

Yet, at a high level, three important questions need to be answered. First, will U.S. monetary policy change? Likely not. But Trump now tells reporters that as president he will have direct say on when and how the Federal Reserve sets interest rates. In a surprise to no one, he claims his own instincts are better than the people who work at the Fed and that Powell will be fired if he doesn’t do the right thing (whatever that is). There is precedent for this. In 1972, Nixon was able to browbeat the Fed Chair into keeping rates low for political purposes. Such interference does risk negative consequences.

Secondly, will U.S. trade policy become less protectionist? Unlikely. Both parties are committed to aggressively pursuing protectionism, despite the fact that tariffs are economically illiterate, prescribing bilateral remedies for more complex problems. Consider that America’s massive trade deficit reflects imbalances with over 100 countries. In a world with globalized supply chains, slapping tariffs on other countries simply diverts trade to higher-cost foreign producers – the equivalent of a tax hike on U.S. consumers, directly weakening consumption and increasing inflation.

Finally, and most importantly, will fiscal policy change? The beneficiaries and relative size of federal largesse will change if the color of the administration changes (our investment team is actively mapping out different scenarios and sectors that will thrive under each presidential candidate). But whether Republican or Democrat, the U.S. government is clearly committed to running massive budget deficits as far as the eye can see. This is the new normal. Notably, both parties support extending most of Trump’s 2017 tax cuts – a move the Congressional Budget Office estimates would add around 20%, or $4.6 trillion, to the deficit over the next decade.

All of the above adds up to a weakening American currency, at a time when the U.S. dollar index is overvalued at comparable levels with past secular peaks in 1985 and 2002.

Next time: Two more pressing questions keeping investors up at night: China stimulus and the Magnificent 7.

Tyler Mordy, CFA, is CEO and CIO of Forstrong Global Asset Management Inc., engaged in top-down strategy, investment policy, and securities selection. This article first appeared in Forstrong’s Insights page. Used with permission. You can reach Tyler by phone at Forstrong Global, toll-free 1-888-419-6715, or by email at tmordy@forstrong.com. Follow Tyler on X at @TylerMordy and @ForstrongGlobal.

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