Catherine Kress, head of Geopolitical Research and Strategy at BlackRock, joins Oscar to explore the macro and investment dimensions of this megaforce, the complex interplay of geopolitics and global markets and provide insights for investors navigating this new era.
In the ever-evolving landscape of geopolitics, the world finds itself at a pivotal juncture marked by structural shifts that redefine global dynamics. The emergence of competing economic and geopolitical blocs stands out as a prominent feature reshaping alliances and influencing international relations. Catherine Kress, head of Geopolitical Research and Strategy at BlackRock, joins Oscar to explore the macro and investment dimensions of this megaforce, the complex interplay of geopolitics and global markets and provide insights for investors navigating this new era.
Oscar Pulido: Welcome to The Bid, where we break down what’s happening in the markets and explore the forces changing the economy and finance. I’m your host, Oscar Pulido.
In the ever-evolving landscape of geopolitics, the world finds itself at a pivotal juncture marked by structural shifts that redefine global dynamics. The emergence of competing economic and geopolitical blocs stands out as a prominent feature reshaping alliances and influencing international relations.
As we’ve learned on previous episodes, the BlackRock Investment Institute has outlined five mega forces that are shaping the macroeconomic landscape. And geopolitical fragmentation is one of them.
To help me explore this topic, I’m pleased to welcome Catherine Kress, head of Geopolitical Research and Strategy at BlackRock. Together we’ll explore the macro and investment dimensions of this megaforce, the complex interplay of geopolitics and global markets and provide insights for investors navigating this new era.
Catherine, thank you so much for joining us on The Bid.
Catherine Kress: Thanks for having me.
Oscar Pulido: So Catherine, we’ve been talking to Alex Brazier from the BlackRock Investment Institute, and one of the things that he’s been mentioning, and that actually has been a common theme throughout a number of our episodes, have been the mega forces of which there are five, artificial intelligence, aging demographics, the transition to a low carbon economy, the future of finance, and last but not least, geopolitical fragmentation. Talk to us a little bit about the geopolitical landscape and what’s changing.
Catherine Kress: So, I think it’s important to take a step back and if you think really to the last half decade or so, it’s clear that we’ve had these cascading events that are really building on each other and now hang over the global economy.
We had the US trade wars back in 2018, 2019, which extended into the Covid pandemic, Russia’s invasion of Ukraine, and now the outbreak of war in the Middle East. These events are really starting to build on each other and drive structural change in the global economy. Our BlackRock view is that geopolitics from an investment perspective has become a persistent and structural market risk.
We saw last year S&P 500 executives use the word geopolitics 12,000 times, which was up three times relative to two years ago. If you look at our proprietary BlackRock geopolitical risk indicators, we see them hit their highest level in the last year. Throughout history, the impact of geopolitics on markets, economies has been fairly short-lived. It’s been modest, markets have tended to fade geopolitical shocks when they happen. We actually did a study several years ago within the investment institute of historical risk events, and that’s what we found that these events had a fairly short-lived, indirect market impact.
We see today’s events as different. We believe that they’re driving structural long-term change, and the world order that’s emerging really stands in sharp contrast to this post-Cold War period, which was characterized by US hegemony, constructive and productive relations between major nations, lower trade barriers, ever increasing globalization. We see today’s environment as different, it’s driven by the emergence of competing economic and geopolitical blocs, competition between those blocs and increasingly less international cooperation.
Oscar Pulido: You mentioned the events that you look back on over, I imagine, many decades. And the fact that the impact on markets was modest and short-lived, but you’ve also said we’re in a structurally different world with respect to geopolitics. So is it fair to say that going forward market impact will be less short-lived and more impactful?
Catherine Kress: Sure, I mean this is a discussion that we’re having right now: has the environment changed that much that markets should be treating geopolitical events differently? Our view is, yes. The world today is a lot more connected than it used to be four or five decades ago. So, a risk or a crisis in one part of the world can really emanate and have ripple effects to other areas and other issues.
Oscar Pulido: You mentioned the Russia, Ukraine war, people saw their food prices going up and some of that is because of the production of grains in that part of the world that was impacted. You also mentioned competing economic blocs, competing geopolitical blocs that are being formed. So, talk a little bit more about that evolution.
Catherine Kress: So really, over the last several years, we’ve seen the rise and emergence of these competing economic geopolitical blocs. This is one of the key fixtures of this fragmented landscape. On the one hand, you have the US which is as unified as it’s ever been with its allies in Europe and Asia.
You see that with the expansion and solidification of NATO in response to Russia’s invasion of Ukraine. We’ve seen the rise of multilateral fora like AUKUS and the Quad, but meanwhile we have China and Russia who are cooperating more closely than they have, and they’re partnering with countries like Iran and in some cases North Korea. These powers are working together more closely than they have in decades, and that’s something that we’ve really seen evolve and deepen over the last several years.
I mentioned Russia and China growing particularly close. There’s been some interesting data points recently that show that. So, for example, China Russia dollar denominated trade last year hit $240 billion, which was 26% increase from a year earlier. Today, China trades more with Russia than it does with Germany. If you look at China’s exports of transportation equipment specifically to Russia, that’s up 800% since Russia’s invasion of Ukraine. And we now see that Chinese cars make up 55% of the Russian market.
But I mentioned this informal alignment, deepening as well between Russia, China and North Korea and Iran, and there’s some interesting data points here as well. For example, Iran has become a principal supplier of drone technology to Russia. We’ve seen North Korea provide more munitions to Russia in its invasion of Ukraine than Europe has provided to Ukraine. And Russia’s providing its partners with supplies too, for example, cheap energy, natural gas. Increasingly, there’s concerns about Russia exporting military technology and equipment to Iran and North Korea. So we’re seeing these blocs harden and they’re increasingly competitive with each other.
Oscar Pulido: And at the same time that these blocs are forming, I think there’s another term that you’ve used, which are these multi-aligned countries, that are also developing. I’m thinking of these countries as I think they’re friends with everybody, or at least maybe they’re not taking a particular side when it comes to some of these economic blocs. But maybe help clarify, when we say a multi aligned country, what does that mean and what are some examples of some of those countries?
Catherine Kress: So, these are the countries that haven’t taken sides in the contest between the US and China, or necessarily adopted the western position on Russia. They’re very different from the non-aligned movement of the Cold War. So, we’ve chosen the phrase multi-aligned because we see these countries as fundamentally different.
The non-aligned movement of the Cold War was much more about statements and posturing and protests. Today, the multi-aligned countries are major economies in the world that have a lot of power and influence.
The Economist calls them the “Transactional 25” or the T25. Together, the T25 make up more than half the world population and about a fifth of global GDP, which is more than the EU. The multi-aligned countries are pragmatic. They have a fluid transactional approach to the world. In a way, they’re uncertain about the future distribution of power, and so they’re hedging their bets and aligning with both blocs in line with their national interests.
An especially important grouping of multi-aligned nations are the countries in the Middle East. So, years of high oil prices have made the countries, the Gulf Oil producers specifically, really primary sources of liquidity in the markets. we think that they’re at an inflection point. They’ll be the last one standing in fossil fuels. They have enormous opportunity if they can continue to maintain fiscal discipline, if they can manage regional tensions.
But another multi-aligned player to watch is India. India’s already the world’s most populous nation, its working population is expected to hit a billion within a decade. It’s projected itself as a leader of the global south.
So, we have demographics alongside macroeconomic stability, as well as a focus on physical and digital infrastructure that I think make India really well poised, to compel global growth going forward.
Oscar Pulido: One of the things that emerged post-Covid was this recognition on the part of companies to bring production closer to home. Prioritizing resiliency more than cost, I think is a lot of what we’ve talked about with some of our guests on the podcast. And some people talk about this as de-globalization that after many decades of globalization, now we’re going in reverse. Maybe Alex Brazier has talked about it as the rewiring of globalization. So, what is the right term and do you agree with this and what are the sort of the impacts if this trend in fact is happening?
Catherine Kress: I very much agree with the framing as the rewiring of globalization. I don’t think it’s correct to say that the world is deglobalizing, that we’ve hit the end of globalization. There are measures of globalization that have receded. For example, trade as a percentage of GDP since the financial crisis. But there are other areas where we’re seeing rapid globalization like digital trade and services.
But I do think it’s fair to say that the system of globalization has been politicized and that we’re seeing issues, as you said, like national security resilience, increasingly making their way into economic policy, business decision making, and we’re seeing countries and companies leverage targeted policies like export controls, tariffs, investment restrictions, trade agreements with like-minded countries to achieve economic and policy objectives.
So, our view is that globalization is rewiring, and this is a dynamic that we were hypothesizing for some time that national security and resilience would drive this rewiring and increasingly play almost a bigger role than traditional economic and market factors like pure cost efficiency, comparative advantage, in supply chain decisions.
And increasingly, there’s a critical mass of studies coming out that supports that hypothesis. That policy and geopolitics are driving this rewiring of globalization, and at a high level, it shows that trade isn’t necessarily declining, but it is shifting, and we’re seeing this in a couple of specific areas.
First, we’re seeing that trade between geopolitical blocs is slowing. So, since Russia’s invasion of Ukraine, the World Trade Organization has reported that trade between geopolitical blocs has grown 4-6% slower than trade within the geopolitical blocs. And today, China’s trading more with developing countries than it is with the US, Europe, and Japan combined. So, we’re seeing that kind of shift among the blocs.
Second, we are seeing some reduced dependence on cross border suppliers. So, there is an element of that reshoring that’s taking place. Third, and this is what I think is the most interesting and presents an investment opportunity, which is that as we see trade between the blocs decline, we’re seeing the rising up of countries, which Bloomberg has referred to as the connector countries.
These are the countries that are injecting themselves into global supply chains and becoming intermediaries. So, as US direct sourcing from China declines for example, countries like Vietnam, Mexico, Indonesia, Morocco, Poland are inserting themselves into global supply chains, and China’s trading more with them and they’re trading more with the US.
So, the US isn’t necessarily reducing trade exposure to China entirely, but it’s being more intermediated. These countries, according to one Bloomberg analysis, reported $4 trillion in economic output in 2022. They’ve all seen trade grow above trend for the last five years. So, they reflect a really interesting and important opportunity going forward.
Oscar Pulido: So, let’s go back to the fact that you said some of these geopolitical changes, or all the geopolitical changes you’re mentioning are more structural in nature. That this isn’t just a one- or two-year type of trend, but that, the world is fundamentally shifting. So, what does that mean for future geopolitical shocks, like how should an investor or just individuals be thinking about them as opposed to what they’ve seen in the past?
Catherine Kress: So, we had this conversation with a number of our investors recently, and I thought something that was interesting that emerged from that conversation is that fragmentation on its own doesn’t necessarily need to massively disrupt core investment theses, it’s a structural trend as I said. So, there are elements of it that we can track, that we can build into our investment hypotheses. We may get to a more stable world order over the longer term, but the path to getting there in our view is going to be very rocky. And so, what’s critical for us to watch as investors is whether this kind of transition to a more fragmented world order is a managed and orderly one, relatively speaking, or a chaotic and disorderly one.
By all counts, we are in a more volatile world order right now. The UN reported last year the largest number of violent conflicts underway since World War II and we’re facing the largest election year in history with 76 countries or so going to the polls next year. So we are trying to identify what are the types of risks that could change that fragmentation path and disrupt core investment theses. There’s a range of them, we feature our kind of top 10 risks on BlackRock’s geopolitical risk dashboard, which you can see on the web, but I’ll mention three specifically. So, the first is the competition between the US and China. We see US China competition really as the new normal for US-China relations.
It’s focused on the defense area, but it’s focused very sharply in the technology area. Where the US is really pursuing a policy of protecting, defending, extending its lead in the most advanced technologies that it sees as having military applications like AI, quantum computing, semiconductors. China is responding by investing in its own indigenous technologies, which we believe will lead to parallel competing tech stacks for the most important technologies.
This is one area that we’re watching. But a conflict over Taiwan, conflict in the South China Sea would be massively disruptive to markets. So, these kind of competitive dynamics are areas we’re monitoring. Another area is the ongoing conflict in Ukraine. At this stage, we don’t see a diplomatic solution as likely in the near term.
We believe a long-term standoff between the west and Russia is likely. So, we’re just ever monitoring the potential risk of escalation there. And then third, we have the ongoing war in the Middle East and here, we are very closely monitoring the risk of escalation as well. We’ve seen recent attacks on shipping in the Red Sea as an example of how conflicts can disrupt shipping, lead to higher production costs, contribute to potential inflationary outcomes.
So, these are types of geopolitical risks we’re monitoring as affecting the path of fragmentation going forward.
Oscar Pulido: And it’s worth mentioning the geopolitical risk indicator that you talk about. There might be, I think you mentioned 10 different geopolitical risks that you’re monitoring, but you don’t necessarily view the risk of them all the same. The risks can vary based on what you’re observing in the market.
Catherine Kress: Absolutely. So, one thing that we try to do as we assess the risks is provide both kind of a subjective assessment as to how we see the risks evolving, but then also a quantitative assessment as to how markets are paying attention to them if they are or aren’t.
So, these geopolitical risk indicators that we have are a quantitatively driven measure of market attention or investor concern about a particular geopolitical risk, and it’s a sort of proxy for market pricing. Our belief is that if markets are paying attention to a risk, it’s more likely they’re pricing that in. So we try to identify the disconnects between our subjective assessment based on subject matter experts, and this quantitative assessment based on natural language processing of brokerage reports, financial news, media, and the like.
Oscar Pulido: And the inverse of that is where you think the market is not paying enough attention to a geopolitical event. It could actually pose a higher risk because markets are ignoring it and maybe they shouldn’t be.
Catherine Kress: Exactly.
Oscar Pulido: Can we just talk then finally about the bottom line for investors? If I’m listening to this and thinking about the structural changes in geopolitics and what that means in the years ahead, what does that mean for my portfolio? You mentioned that investment teams shouldn’t necessarily, in your opinion, be changing their core investment thesis, but what does an end investor need to think about?
Catherine Kress: So, the geopolitical moderation of the post-Cold War period that we talked about was generally supportive of lower inflation and higher growth.
We see this period of geopolitical fragmentation as inflationary and potentially likely to dampen growth going forward. We worry that as supply chains get longer and more complex, that is going to be expensive. It could weaken productivity in developed markets. And then meanwhile, we have structural economic challenges in China, which could present a drag on global growth going forward.
So, from a macro perspective, we see geopolitical fragmentation as inflationary and likely to impact growth in a negative way. But from an investment perspective, we’re looking at relative opportunities where things are priced or not priced. And we can look at this geographically. So, for example, the connector countries that I mentioned are already benefiting from a diversion of trade and investment flows.
So, we think that there could be relative opportunities in those countries. From a sectoral perspective, a parallel dynamic that’s underway is, as countries are – as these blocs are hardening as countries are turning inward, we’re seeing a surge of industrial policy in strategic sectors and areas of focus like clean energy, like advanced technology.
And so, we can look at some of those areas for opportunity as well. So, the bottom line for investors is that while fragmentation may be inflationary and impact growth over the long term, we see relative investment opportunities both geographically and at the sector level.
Oscar Pulido: And it rhymes with what the BlackRock Investment Institute and Alex have been talking about being nimble, being agile, and perhaps being more granular in this new macro regime that we talk about.
Catherine Kress: Exactly, and fragmentation will create dispersion. And so that does allow investment skill to shine in this environment.
Oscar Pulido: Catherine, listeners who have been following the podcast closely will know that you have both hosted and now, served as a guest of the podcast. So I hope you enjoyed sitting in the other chair today. Thank you for joining us on the Bid.
‘With Highest Number of Violent Conflicts Since Second World War, United Nations Must Rethink Efforts to Achieve, Sustain Peace, Speakers Tell Security Council’ UN Press Release January 26th 2023;
‘2024 Is the Biggest Election Year In History, The Economist Nov 13th 2023
These Five Countries Are Key Economic ‘Connectors’ in a Fragmenting World, Bloomberg November 2nd 2023
The Larger Geopolitical Shift Behind Iran’s Drone Sales to Russia, Carnegie Endowment For International Peace, October 26th 2022
War in Ukraine Has China Cashing In, New York Times, December 21st 2023
Robin Brooks, X
China-Russia 2023 trade value hits record high of $240 bln – Chinese customs, Reuters, January 12, 2024
“Gauging geopolitics”, BlackRock Investment Institute
The Global Economy Enters an Era of Upheaval, Bloomberg, September 18th 2023
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