We see escalating tensions in the Middle East as a sign we’re in a new geopolitical regime. The first direct strikes between Israel and Iran structurally raise risk in the region, in our view. The strikes come as Iran has used proxy attacks by the Houthi rebels on ships in the Red Sea as a response to the war in Gaza. These attacks upended supply chains, diverting swathes of goods from the Suez Canal to the Cape of Good Hope. See the chart. Since the attacks began, shipping costs from China are still up about 75% from the end of last year, LSEG Datastream data show. Persistent supply constraints that keep inflation and interest rates above pre-pandemic levels are an upshot of our mega force view. The International Monetary Fund’s recent discussions on the growth impact of structural challenges – like geopolitical risk and other mega forces – reflect similar thinking to ours.
Since we rolled out our mega forces framework last year, we have seen more evidence that these forces are a useful investment lens. We think the geopolitical turmoil in the Middle East has lowered the bar for escalation in the region – upping the chances of persistently higher oil prices. Commodity shocks reinforce why governments are prioritizing energy security and affordability alongside decarbonization. The recent events show traditional energy still has its place, even in the low-carbon transition – and can be a buffer against geopolitical risk.
Supply constraints at work
Population aging is another example of supply constraints playing out in real time. Shrinking working-age populations in developed markets are limiting productivity and output. An unexpected jump in immigration in the U.S. and other major economies offsets the impact of a dwindling domestic workforce for now. Yet we find this effect must persist for some time to outrun adverse demographics. We look to this week’s U.S. payroll data for signs immigration is still supporting labor markets.
A resilient U.S. jobs market marked by persistent wage gains is keeping services inflation elevated. Markets now expect fewer than two Federal Reserve rate cuts in 2024, down from seven earlier this year. Higher-for-longer rates could keep squeezing bank deposits, where interest rates have lagged the Fed policy rate – unlike yields on money market funds. Plus, banks face stricter regulations. We like private credit – where default rates have fallen three quarters in a row – over public on a strategic horizon of five years and longer. Private markets are complex, with high risk and volatility, and aren’t suitable for all investors.
One mega force that could ease supply constraints? AI. We think AI could deliver strong efficiency gains across sectors. We watch for AI adoption to broaden beyond tech – into sectors like healthcare, communication services and financials, and into applications like data centers and infrastructure. We see a high bar for Q1 mega cap tech earnings to beat lofty expectations. Early results have skewed positive – yet any signs of weakness could trigger a change in our U.S. stock view.
Our bottom line
Mega forces provide a useful investment lens now, not just in the future, we think. We like energy stocks as a buffer against geopolitical risk. We prefer private credit over public on a strategic horizon. We stay overweight the AI theme.
