With America's leadership waning, the G20's role as a central institution for global co-operation is more important than ever. While this week’s meeting might not produce concrete actions, participants will address tough issues like protectionism, trade imbalances, currency manipulation and financial-market regulation.
Who's leading the world now?
As Germany prepares to host this week's G20 meetings in Baden-Baden, one question will hang over this spa town like a cloud: "Have we left the world order that lasted 70 years under Pax Americana?" As the group looks for answers, its discussions and eventual pronouncements on four topics will be significant.
The forces that helped US President Donald Trump rise to power have not been placated by his election. The changes expected to be made to US trade policy are being echoed around the world by anti-globalization politicians and voters. Indeed, it speaks volumes that China's president, Xi Jinping, is expected to be the meeting's most vocal supporter for global free trade. Unlike at previous G20 summits, we don't expect to see any unashamed celebration of free trade at this year's meeting. Instead, participants will unite under the banner of "fair globalization" in a bid to signal that a new form of collaboration is possible.
2) Trade imbalances
Because of its high trade surplus, Germany is facing reproach from G20 members running trade deficits – which not only includes members in Europe, but the United States as well. It is therefore quite conceivable that Germany will issue cautious signals about increasing government spending in areas such as defense that could lower the trade imbalance.
3) Currency manipulation
While connected to trade surpluses, no large country meets all of the US government's formal criteria for currency manipulation. What's more, Germany is a euro-zone member and therefore somewhat shielded from these accusations. As such, these discussions may be heated, but they are not likely to produce any concrete sanctions. China, however, will remain under careful scrutiny.
4) Financial-market regulation
Establishing a global framework for the smooth functioning of financial markets is crucial for creating a level playing field for the international banking sector. Yet if there is no agreement among G20 members, Europe's banks will suffer more than their US counterparts. This seems particularly relevant given the United States' current flirtations with deregulation, including a possible repeal of the Dodd-Frank Act.
The G20's role in a fractious world
In conclusion, the meeting will reflect a world of increasing geopolitical confrontation. And while concrete actions will be few and far between, the willingness of participants to break with consensus will be significant. Nevertheless, in an increasingly fractious world, the G20 will be more important than ever in its function as a center for co-operation.
Now that the initial volatility has passed, the UK is in a better post-Brexit position than Europe – at least for now, says our global strategist. But an overall feeling of uncertainty will make the hunt for income a key theme for the rest of 2016.
Global markets have been regaining some much-needed poise in recent weeks as the volatility of the unexpected Brexit decision has begun to subside, with regions around the world responding to their own particular rhythms while singing a similar overall tune. At the same time, global economic uncertainty – which, in keeping with our financial repression theme, was already high – has been exacerbated by a range of factors beyond Brexit, including terror attacks in Europe and an attempted coup in Turkey.
The hunt for income is a long-term trend that should primarily benefit assets in the US and Asia
It would therefore seem prudent to expect more political uncertainty on the horizon, especially given Europe's upcoming referendums and November's US elections. Factor in this uncertainty with dull economic growth globally, and it becomes clear why investor attention is shifting toward the stability that income generation can provide. This "hunt for income" is a long-term trend that should primarily benefit assets in the US and Asia for the rest of the year.
Europe and the UK
As we expected, Brexit has been affecting Europe more than the UK, which is regaining its balance as it puts a new government in place. Britain's new leaders have a clear mandate to leave Europe as smoothly as possible while, for the first time in 40 years, engaging more constructively with the rest of the world. With the pound sterling moving lower in a post-Brexit world, the UK's economy will face headwinds, yet it should also benefit from additional proactive monetary stimulus measures and investments from the central government. Sterling's downward trend has given solace to UK-based international corporations, which has helped the UK outperform Europe so far.
Europe, meanwhile, faces a period of political uncertainty as Brexit takes its toll, but the region should be less affected economically by any serious consequences even as it remains very sensitive to the dull global growth environment.
Equities in the UK and Europe look undervalued, but they are also now "cheap for a reason"
Both markets have experienced a flight to safety as investors reallocated toward sovereign bonds, which were already moving higher in Europe thanks to the European Central Bank's policies. This boost for bonds comes at the expense of equities, with financial companies in particular hurt by the uncertainties that Brexit has created for regulation, "passporting" and economic growth. Overall, it appears that equities in the UK and Europe look undervalued in a global context, but they are also now "cheap for a reason". This environment may last for a few years, unless or until negative interest rates force Europe's cash and bond holders to seek higher equity yields.
Now that the initial shock has subsided, Asia has been generally unaffected by Brexit; instead, more significant local situations have been developing:
- China continues to stabilize as it enacts its next five-year plan.
- Prime Minister Modi of India is continuing to make positive legislative progress; he is also recovering from the impacts of a poor start to the monsoon season and the loss of the Reserve Bank of India's governor.
- Japan has re-elected Prime Minister Abe, who now seems ready to move to "Abenomics 2.0", although it is unclear if this shift will include actual structural reforms rather than just more QQE from the Bank of Japan and more fiscal stimulus from the government.
With Europe clouded by uncertainty, Asia and emerging markets offer a combination of alluring factors
At the same time, Asia remains very sensitive to the strength of the US dollar and to global trade activity, which remains in the doldrums. With Europe still clouded by uncertainty, Asia and emerging markets now offer a combination of alluring factors:
- For equity investors, Asia has undervalued markets that also provide the potential for some earnings growth.
- For investors who feel unwilling or unable to take equity risk, Asia offers high-yielding local and hard-currency sovereign bond investments.
The US has become the post-Brexit world's default "safe haven", with the US dollar getting stronger and global buyers of US Treasuries driving yields lower. Hard-currency high-yield bonds are still attractive and, despite the United States' dull but solid economic progress, the US Federal Reserve still wants to move US interest rates higher. As a result, while US equity valuations are stretched and earnings expectations are still muted, the US has become the safest place to take a moderate amount of risk in exchange for modest return potential.
Of course, political risks are clearly rising in the US, and that will add to the overall market volatility that we anticipate will peak in November. Nevertheless, when compared with ongoing difficulties in Europe, the challenges the US is facing may begin to seem increasingly manageable to a growing number of investors.