Allocators and asset managers alike now find themselves forced to pay close attention to geopolitics. What was once seen as tangential, episodic risk is now very clearly shaping the bones of the market itself and cannot be ignored during portfolio construction.
The question is no longer whether geopolitics will flare up, but when, and how badly. Institutions from the Fiduciary Trust, to the World Economic Forum and the Harvard Business Review have pointed to the heightened tensions as a trend that will exacerbate deglobalization as rifts widen between countries.
But Neil Shearing, the group chief economist for London-headquartered Capital Economics, rejects this concept of de-globalization. Trade figures remain buoyant as a share of global GDP, and capital and labor remain at elevated levels. What has changed, he says, are the political fault lines along which the world is forming.
Instead of de-globalization, he believes we are in the middle of a repositioning of alliances and cooperation that is causing economic fracturing, with one camp gravitating toward the U.S. and the other to China. As the author of The Fractured Age: How the Return of Geopolitics Will Splinter the Global Economy, Shearing outlines what business and government leaders should be doing to adapt to this new world.
Investors must now consider how deep geopolitical rifts run and whether the impact extends beyond those sectors currently most affected, like biotech, semiconductors, and sensitive dual-use technologies. With fault lines switching on an almost daily basis — such as with Venezuela, once a close ally of China — managing geopolitical exposure within portfolios has become a core investment discipline.
Institutional Investor spoke to Shearing about his hypothesis, how it has changed in recent weeks, and how investors should be thinking about geopolitics.
Thanks for your time, Neil. Do you want to start with an overview of the hypothesis you wrote your book about, and the concept of fracturing?
The book is rooted in the first Trump administration, when there was a bit of a push back to the period of globalization in the 1990s when tariffs were put in place on China and some other economies. That gave rise to a lot of headlines and rhetoric like: “the world is turning inwards,” “we're going back to the 1930s,” “globalization is over,” and “the world's de-globalizing.”
But the more I looked at what was happening, and frankly, the data too, it became clear that globalization was not ending. In fact, global trade volumes as a share of world GDP are still close to record highs: Global capital flows are off their peak in 2007, but that was an unusually high peak, and global capital and people flows are still extremely high by historical standards.
So, it became clear that the world was not de-globalizing. My question, then, is what is happening? And the more I look at it, my view became that what is happening instead is the intensification of a superpower rivalry between the U.S. on one hand and China on the other. The two are pulling apart — there is evidence in trade flows, capital flows — and other countries are being forced to pick a side.
What does this mean for asset managers and allocators specifically?
Yes, the key question is what it means for the global economy and the financial markets. The economic implications of fracturing will be governed by two things. The first is the fault lines of factoring: Does it affect all trade and capital flows, or is it confined to particular sectors that are geopolitically sensitive?
The second is how do other countries align in these blocks; do they align more with China or more with the U.S.? That’s going to govern the economic consequences, and therefore the market consequences. In terms of the contours of the fracturing, the evidence so far is that it’s being confined largely to sectors that one might describe as being geopolitically sensitive, so anything that compromises supply chain security, national security, global technological leadership like biotech chips, critical minerals, or anything that’s got dual use. Drones have applications in civilian and military life, for example.
The U.S. block has a substantially greater economic heft of global GDP than the China block at this stage. The key question is whether the Trump administration’s policies push more countries out of the U.S. orbit and closer to China. If fracturing is contained to these geopolitically sensitive areas, and the U.S. block holds together, then the economic costs are manageable, and they fall mainly on the China side.
The market consequences are that allocators need to think more carefully about allocating to sectors that are geopolitically sensitive, but otherwise we shouldn’t see major market losses or debt and asset prices diminishing. But if the U.S. block fractures itself and more countries move to the China block, then the economic cost for the U.S. will be greater and will have an implication for asset prices. Then clearly the implication for asset prices goes beyond these geopolitically sensitive sectors and affects the economy more widely.
You touched on it a little just now, but has the new administration been the driver of this change or was it something that was already underway?
Under the Biden administration, and even under the first Trump administration, the focus was clearly on containing China. In the second Trump administration, there has been broader push back against traditional allies and partners in Europe, India, Japan. Those countries have responded in different ways. So Canada and Europe, they’ve responded with a pushback in rhetoric, pushing back against U.S. aggression, and trying to stand up for the rules-based global order.
But they have not done a great deal. Europe, in particular, is much more concerned about keeping the U.S. security umbrella intact and American support for Ukraine. The tariff deals had rates that were more favorable to Europe than China. Some countries like India that weren’t so strongly allied to the U.S. in the first place really leaned away from China but are less certain since Trump took office. In contrast, Saudi, which leaned towards China, has shifted more towards the U.S. One of the key points in the book is that the contours of the fracturing map are fuzzy, and some countries will shift between blocks.
What are the economic consequences of fracturing over time?
Anything that creates friction within the global economy will incur some kind of economic losses. Globalization produced economic gains because it basically forced the global economy to act more like a national economy, removing friction between borders for goods, capital, and labor.
Anything that imposes friction will impose costs. The question is the degree of friction, and therefore the degree of costs. If the friction is contained to strategically important sectors, then maybe the loss of global GDP will be something like 1 percent over several years — that’s not a big deal, that is manageable. If you get a much wider split between the blocks, then the economic costs could be much greater, closer to 4 or 5 percent of GDP. That is similar to the kind of losses that we saw during the global financial crisis.
The worst-case scenario would be if these two blocks ever came to conflict, Taiwan being the obvious flash point. If there’s a conflict over Taiwan, then the economic costs of that conflict become a secondary consideration.
Things have changed quite dramatically in a short space of time, with flash points in Venezuela, Greenland, and Iran adding to those in Ukraine and the Middle East. Have these recent events altered your hypothesis at all?
The big shift over the last couple of months has given rise to this idea that we have moved back not to a world orientated around geopolitical blocks, but to a hemispheric approach. This would mean the U.S. is the dominant power in the Western Hemisphere, Russia the dominant power in Eurasia, and China the dominant power in Asia Pacific.
This geopolitical arrangement would determine global political and economic outcomes and pose a challenge to the fracturing thesis. The problem with the hemispheric approach and spheres of influence of this kind of framework is that it envisages a world that divides into neat, geographically contiguous blocks. That is not the case.
And implicit in that is that idea that the U.S. is no longer a global power, but a regional power. And yet that is inconsistent with what we’re seeing. Just look at Iran: The U.S. is deeply concerned about what’s happening there. In the last 12 months, the U.S. has taken military action not just in Venezuela, but in Nigeria, Yemen, Syria, and is engaging more proactively with Saudi Arabia. Yes, the U.S. is recalibrating its relationship with Europe, but it is not pulling back from the global stage. Both China and the U.S. still consider themselves as global, not regional, superpowers.
Do you think that allocators and managers are rethinking strategies because of these events?
If there was any doubt that geopolitics has returned as a driver of policy decisions and economic outcomes, then that is no longer in doubt after the events of the first week of this year.
But it is important not to overstate things too much. If you look at the impact in markets of events in Venezuela, collectively it’s been negligible. Oil prices are down, stock markets are still at record highs — any concern has been much more about institutional shifts in the U.S. and the power of the Federal Reserve.
Allocators are now thinking about geopolitics constantly as part of their frame of thinking about how to allocate, and how particular firms, regions, or countries are exposed to these geopolitical shifts.
Before then, it was still possible to believe in the idea that a rules-based globalized order would persist, even with the use of tech controls, for example, during the first Trump administration and from Biden. But now the second Trump administration, with the use of tariffs, has led an even greater push back against China.
Do you think investors around the world are looking to derisk from the U.S.?
For global investors, there should be a strong, relevant degree of sectoral and regional diversification within portfolios anyway, but over and above that, it’s very difficult to significantly divest from the U.S. because such a large share of global asset markets, and frankly, the world’s most profitable, fastest growing companies are in the US. So it’s something that investors have to manage. Rather than pull back completely, you have to manage the risks.
