Joachim Klement, CFA: Three Geo-Economics Trends to Watch
“Today’s investors need to understand geopolitical trends as a main driving force of markets.” — Joachim Klement, CFA
Joachim Klement, CFA, has emerged over the last decade as one of the more insightful and compelling voices in finance. Well-reasoned, rigorous, humorous, and occasionally iconoclastic, his perspective, featured here on Enterprising Investor or on his personal site, Klement on Investing, is always an essential read.
Trained as a physicist and mathematician, Klement came to finance by an unconventional route, and applying a multidisciplinary approach is a hallmark of his analysis. He incorporates different perspectives and isn’t afraid to take on the orthodoxies of conventional finance.
His latest monograph, Geo-Economics: The Interplay between Geopolitics, Economics, and Investments from the CFA Institute Research Foundation, is a vastly ambitious endeavor. That is, Klement surveys the literature and attempts to identify and analyze the geopolitical undercurrents influencing the economic future and determine which ones may impact markets, which ones probably won’t, and how investors can discount for them. Climate change, war and terrorism, resource scarcity, big data, and a host of other issues he explores in depth and considers how each phenomenon affects the markets, or doesn’t, and how analysts should approach them.
For his perspective on Geo-Economics, and market conditions in general, I caught up with Klement earlier this month. What follows is a lightly edited reproduction of our exchange.
CFA Institute: So tell us about Geo-Economics. What was the initial impetus for writing it?
Joachim Klement, CFA: I have always been a politics junkie, but when it came to translating political developments into my investment portfolio, I found the analysis wanting. The vast majority of geopolitics advisers are trained political scientists and don’t have a finance background. This means they typically are unable to differentiate between what matters for investments and what doesn’t. I wanted to write a book on geopolitics from the perspective of an investor.
You wrote in back in 2019 that geopolitics and populism were creating a new market narrative to succeed the quantitative easing (QE), central banks-focused market regime. How has researching and writing the book influenced your perspective on that?
It confirmed the 2019 post. I think that the 2020s will be driven by three major geopolitical themes. First, climate change and the switch from fossil fuels to renewable energy sources will lead to significant shifts in the political landscape and produce winners and losers in financial markets.
Second, the rise of China and its increasing role in the world will transform international trade and intensify competition between Western companies and Chinese challengers.
Third, in a world where data and access to it is increasingly important, cybersecurity and cyberwarfare will become increasingly important threats to private companies and society overall. It’s a little known fact but already today the cost to the US economy from cybercrime is somewhere between 0.6% and 2.2% of GDP. And out of 1,300 companies surveyed in 2018, two-thirds said they were targets of cyberattacks, each company losing on average about $16 million per year.
What was the most surprising discovery you made while researching Geo-Economics?
The cost of cybercrime was one of the most stunning statistics. But surprises are everywhere.
Take the rise of China. We all have heard of the Belt and Road Initiative to finance infrastructure that ensures China has access to resources, suppliers, and end customers. But China is also working behind the scenes to make sure that Huawei and other Chinese manufacturers will not be excluded from 6G and other future technological standards that will shape the next decade and beyond.
Don’t get me wrong, China has every right to exert its influence on regulations and standards. All I am saying is that most investors underestimate the influence China already plays in the world economy and how it is working to become even more influential over the next decade.
One area Geo-Economics doesn’t really explore in depth is pandemics. Do you see the COVID-19 crisis as a geo-economic event?
To me, the pandemic is not a geopolitical event because it is not triggered by political developments or has caused any major political frictions. I consider it to be an external shock that is short-term in nature.
Having said that, China has managed to digest the pandemic much better than most countries in the West and is already growing its economy at levels above the pre-pandemic ones. Meanwhile, we in the West are trying to climb out of the hole we dropped in last year. This means that the rise of China has been accelerated by the pandemic.
You predicted last year that less would change as a result of COVID-19 than we expected. What do you think will change now?
Not much, in my view. I think it will take longer than many people expect to get back to normal and I don’t expect to throw away my masks or go on an international vacation in 2021.
The other thing that might change is that flexible work arrangements have become somewhat more accepted in the sense that many people will want to work more often from home. Having said that, I don’t think that work from home will become the new normal or that office space for businesses will be reduced significantly. There is enormous value in the personal interaction between people that is impossible to replace by video conferencing. And recent surveys from Microsoft and other companies show that this is indeed the case.
The pandemic and work from home has caused a lot of damage to our productivity and our professional networks. Yes, we are busy and seemingly more productive because we seem to get more things done. But getting things done and being creative and productively changing your business are two entirely different things.
International cooperation was central to both victory in the Cold War and underpinned the post-Cold War world. Populist currents have undermined those international structures of late. Do you see anything that suggests that trend won’t continue?
It is really hard to tell right now. There are clear populist trends across the world. But at the same time, countries like Germany seem to swing away from populist parties in reaction to their abysmal failure during the pandemic. It will be interesting to observe in the next one to two years if the rise of populists will accelerate again as the pandemic fades into the background or if these politicians will permanently lose influence.
How do you see this new geo-economics era evolving?
Both the rise of China and climate change will be important drivers of markets and the global economy in the next decade. As an investor I focus more on the rise of China in the near term since this is an imminent development that in my view will have to be resolved in the next three to five years.
Climate change should be resolved by then as well, but I think this is an issue where we as a global society will try to kick the can down the road as long as we can. That means the damages will pile up and we will only seriously solve the problem when it is too late or almost too late. So there, I would expect this topic to be the dominant topic of the second half of the 2020s.
You’re based in London. What’s your outlook on the geopolitical fault lines in the United Kingdom? Brexit looks to be on course but has complicated the situation in Northern Ireland and hasn’t exactly decreased the likelihood of a second Scottish independence vote. So if you were to stick your neck out, are these tensions investors should keep an eye on?
When it comes to the situation in Northern Ireland, I am pretty relaxed. We know from the history of the Troubles that it is a political problem and many geopolitical pundits will have a lot to say about it, but as an investor it is essentially a non-event. Northern Ireland is simply too small to make a difference.
The situation in Scotland is somewhat different. I think it is pretty likely that in the next couple of years, we will see another referendum on Scottish independence and I wouldn’t be at all surprised if Scotland decided to leave the union. That would be very bad for both Scotland and England and would likely cause a recession in both countries. So it would have a material impact on UK equities and bonds. But beyond that, I have a hard time seeing any major impacts.
And in the United States, has the 2020 election, the post-election turmoil, and the first 100 days of the Joseph Biden administration changed your perspective in anyway? Are you more bullish or less bullish on the United States?
I am more hopeful that the United States will catch up with Europe on crucial issues like climate change. Every survey in the United States shows that not only the majority of the population but also the majority of Republican voters now agrees that climate change is real and that the United States is already impacted by it. This is strangely a view that hasn’t made it into the heads of investment professionals in the United States and with that come a lot of missed opportunities.
Just think of it this way: Surveys show that investors are willing to forgo some return to invest in a more sustainable portfolio and they are willing to pay about 0.5% more in fees per year to invest in portfolios with a sustainable investment angle. Yet, many fund managers refuse to integrate ESG into their portfolios even though they could earn more money and attract more investors.
What’s next? Do you have any new books in the works? Is there any area of the market you’re keeping a particularly close eye on these days?
I am way too busy at the moment with my job and writing a new post every day for my Klement on Investing newsletter. So, no books in the works for now. But I might think about expanding my reach in the United States a little bit in the future. We’ll see . . .
Anything I haven’t asked but should have?
Everybody asks me these days where inflation heading. So, I am glad you haven’t asked that question because I don’t want to answer it anymore.
A geopolitical question that very few people are asking right now is the risk of data theft and cyberwarfare. I think this is an underestimated risk at the moment even though as I said, it causes a lot of damage and, as I describe in the book, has the potential to cause another financial crisis or a severe recession if the cyberattack is large enough.
Many thanks, Joachim.
For more from Joachim Klement, CFA, don’t miss Risk Profiling and Tolerance: Insights for the Private Wealth Manager, from the CFA Institute Research Foundation, and sign up for his regular commentary at Klement on Investing.
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All posts are the opinion of the author. As such, they should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute or the author’s employer.
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