Investors are largely factoring in a likely recession this year, coinciding with a peak in inflation, interest rates, and the US dollar.
But a new analysis from Robeco’s head of multi-asset strategies, Colin Graham, has flagged a number of factors with the potential to “derail” the market’s central scenario for the global economy.
“The current consensus isn’t that rosy, but if history tells us anything, it’s that nothing is ever set in stone,” Mr Graham said.
Graham has listed 10 “black swans”, which could trigger either positive or negative deviations from the central scenario.
Goldilocks revenge
The Robeco analyst’s first “black swan” is bullish, outlining a scenario in which US inflation peaks without a recession, the dollar drops, and the US Federal Reserve takes its foot off the pedal.
“The post-COVID fiscal expansion slows, acting as the brake on excess demand,” he wrote.
“The result for multi-asset investors is that high yield bonds become very attractive as default rate expectations fall.”
Panic stations
Conversely, the Fed could revise its inflation posture, with a 2 per cent target viewed as “far too close to zero”.
“The result would be panic, and bonds denominated in US dollars would see negative returns for the third year in a row,” Mr Graham added.
Deflation disaster
The third black swan is the prospect of deflation, which subdues spending amid expectations of further falls in the cost of living.
This scenario, Mr Graham has warned, would lead to an “outright recession.”
“Here, if deflation has a higher number of hits than inflation according to news-flow data from Wall Street and Main Street, it means that central banks are driving the economy using the rearview mirror, causing a major bust,” he said.
Greenwashing and impact washing
According to Mr Graham, the rise of misleading environmental, social and governance (ESG) claims in the corporate space — both “greenwashing” and “impact washing” — could trigger scrutiny from regulators, the media, and investors.
As a result, large financial institutions, Mr Graham observed, could struggle to evidence their sustainability credentials.
“Rather than focusing on improving their ESG and delivering shareholder value, companies could end up selling or divesting businesses that don’t meet ESG criteria and withdraw from markets where regulators demand higher sustainability credentials,” he observed.
Rewards for risk
Subdued returns on investments with a balanced risk profile for a second year running has been flagged as another downside risk to the central scenario.
“If this happens again in 2023, the implication would be [that] we would see a second year of negative returns in balanced funds, similar to the experience following the tech bubble burst of 2001–2002,” he wrote.
Give peace a chance
On the upside, Mr Graham has claimed an end to the war in Ukraine, which would buck market expectations, and could deliver a “peace dividend”.
“Other countries would then relax their travel and trade restrictions, allowing inflation to fall and supply chains to reshore faster,” he said.
“There would be an energy cost windfall for global economies, especially in Europe.”
Anti-social media
Tighter regulations on social media companies responsible for sharp returns on growth stocks could benefit value stocks.
“We could see another backlash against social media and more regulation on large technology and social media platforms as data protection issues come to the fore again,” Mr Graham said.
“The result would be a change in equity market leadership; value companies with capital discipline and quality earnings would be more highly rewarded on a relative basis.”
Shock regime change
Returning to downside risk, regime changes in advanced economies could trigger major policy shifts.
“This is the first year this century without an election in a G7 country,” Mr Graham said.
“However, we could see a major shift in policy as a ‘major’ regime topples, as witnessed with Boris Johnson and then Liz Truss a month later, resulting in major volatility spikes.”
Upsetting the applecart
Graham has also flagged potential government-induced disruptions to markets, pointing to former British Prime Minister Liz Truss’s “disastrous mini-Budget”, which prompted the Bank of England to take emergency measures to protect the pensions industry.
“In this scenario, private assets see a liquidity drain, liability-driven investment (LDI) structures are questioned, and there is increased scrutiny on banks following a crypto bust,” he wrote.
“This would expose investments that were only funded because cash was ‘free’ at the time.”
Net zero upside
Graham’s final ‘black swan’ is the widespread commitment to achieving a net-zero economy, which he said could “surprise on the upside”.
“There can be no backtracking on climate: the evidence about climate change continues to mount, and COP27 highlighted that political will is key to shaping the balance between climate ambition and implementation,” he said.
“In the long run, achieving energy security means investing more in green technologies and climate solutions to close the gap between ambition and implementation.”
This, he concluded, could result in the establishment of a multinational “super fund”, set up to facilitate the net zero transition with government backing.
