Today’s topic of discussion is Allspring’s Market Risk Monitor, a report that the firm uses to capture, distill, and disseminate headline risks across the Allview investment platform. Ann Miletti, head of Active Equity, and John Hockers, co-head of Investment Analytics, go over the genesis of the report and the top ten risks Allspring currently sees in the market.

 

Announcer: Welcome to the Allspring Global Investments podcast where we explore what’s happening in the markets and discuss our outlook for the ever-changing investment landscape. Thought leaders provide their views on the latest global trends in sustainability, technology, emerging markets, and more. Join us as we take you down the road of investing elevated.

Ann Miletti: I’m Ann Miletti, head of Active Equity at Allspring, and you’re listening to On the Trading Desk®. Today we’re discussing Allspring’s Market Risk Monitor, a report we use to capture, distill, and disseminate headline risks across the Allview investment platform. Joining us is John Hockers, co-head of Investment Analytics for Allspring, who will be providing his insights on this topic. Thanks for being here, John.

John Hockers: Happy to be here, Ann.

Ann: At Allspring, one of our core beliefs is to invest thoughtfully and in order to do that, you have to think thoughtfully. Earlier this year, Allspring introduced the concept of Allview. Allview involves offering unique viewpoints delivered together as one. It encourages independent and thoughtful thinking. It helps us capture the free flow of ideas across the investment teams. Because most of Allspring investment strategies are built from the bottom up, it means that one portfolio might be overweight a certain sector that another team may be dramatically underweight. Or said another way, we don’t push down a top-of-the-house view or ask our investment teams to manage to a view hat’s top down. As long as each of our investment teams are following their investment process and their discipline and have a strong investment thesis behind their decisions, that’s okay. It’s important to know that we measure risks carefully and through many different mechanisms. Our integrated risk reporting systems map position level details of each strategy into real-time portfolio level risk exposures. This helps ensure compliance with specific guidelines, reveals hidden risk concentrations, and other things. The systems allow senior management to see where concentrations reside in the overall business. Risks can also be addressed in ways that are less technical than I just described. One example of this that I would love to talk more about is our Market Risk Monitor. The Market Risk Monitor is produced and distributed by our Investment Analytics team. It highlights risk taken within various portfolios. It challenges opinions and it encourages open discussion. As an investment leader, I’m a huge fan of this approach. I understand how difficult it is to predict top-down views. Whether you’ve been in this business for one year or 50 years, there’s no crystal ball. But with the Allview approach and using the Market Risk Monitor, we encourage multiple points of view and true independent and thoughtful thinking. John, maybe you can tell us more about the genesis of the Market Risk Monitor.

John: Yeah, thank you, Ann. So, shortly after the global financial crisis back in 2008, I was asked during a client meeting, as a risk manager, what keeps you up at night? And at the time, that question was relatively easy to answer because the financial markets had gone through the near-death experience of the financial crisis. So, what we did is we summarized our thoughts, gave them back to the client and really received a favorable response back from them. But that led us to think, wouldn’t this be nice if we had a list that we could use in these types of meetings, that we could use to correlate with our portfolios. And so, we sat down and we created a dashboard where we really looked at these macro market risks. And then we started including that in our monthly risk briefings to you, Ann, and to the other members of the office of the CIO. That worked out really well. We did that for a period of time, and then we decided to extend it to all the portfolio management teams. So, we’ve been sending it for about six or seven years now to all of our PM teams every month to give them our views in terms of what the market headlines are, what’s the most concerning things to the market on any given day. We’ve structured it to be a simple top ten list. So, it helps us quantify things both from a probability and in impact. In that top ten list format, it forces us to really focus in on what we think are the critical most important items that might be impacting the markets. When you let that list grow to 15 or 20, it starts to become a little bit long to read and it includes a little bit more than maybe what you need. And the way I think of it, when we share it with our teams, it’s very much like a mental stress test. It allows us to stress test portfolios either with our quantitative tools or just mentally based on some of those concerns that we’re seeing. And in aggregate, I’ve found that sometimes the best risk management tools are simple tools where you really just look at what is going on in the markets and bring that to reflect back on what’s going on in the portfolios.

Ann: Thanks for that, John. Maybe now’s a good time to dig into some of those top ten.

John: Yeah, absolutely. And for those who are listening to this, we do have our Market Risk Monitor published on our website for the month of July. So, if you have the website available, you can certainly go and read more about these particular items yourself. But for those who are maybe listening to our podcast here in the car, I can go through our top ten, one by one. So, number one on our list, and it’s been on our list for quite some time, is the sustained surge in global inflation rates that we’re seeing in the market right now. Our fear here is that that surge in inflation rates is going to lead to aggressive Fed (Federal Reserve) rate hikes and I think we’re seeing that through the course of this year. Number two on our list is the fear of civil unrest in developing nations. This is primarily being driven by the war between Ukraine and Russia and what that is doing with food supplies and food insecurity for the developing world. Number three on our list is the possibility of an acute recession in Europe. What we mean by that, acute being sharp, a sharp downturn in Europe. What we’re worried about in particular is the cutting off of energy supplies from Russia to the rest of Europe. In that scenario, we could see a number of industries be idled as European governments opt to heat homes versus keep factories running. Number four on our list is concerns about a Chinese debt bubble. This concern is really spilling over from the real estate sector where we’ve had some high-profile defaults and we are nervous about the amount of debt that’s in the Chinese economy. Number five, potential for Russian military action to expand beyond the Ukraine/Russia conflict and maybe enter into the NATO space. We think that could be a very extreme risk if it were to happen. A low probability, but extreme risk, so we’re keeping an eye on that. Number six is another military item and that would be the potential for China and the island of Taiwan having some type of military conflict. So, we have that as number six on the list. Number seven, which is new to our list this month, is a concern around the potential tightening by the Bank of Japan. Japan has a yield curve policy of keeping the long end of their yield curve at 25 basis points. And so, one of the things we are keeping a close eye on is whether the Bank of Japan is going to change from that policy, which has really been in effect for decades. So that’s number seven on our list. Number eight is the concern for higher taxes in the U.S. A potential budget deal may be on the horizon between members of the Democratic Party and so we could see potentially higher taxes here in the U.S. Number nine on our list is the potential for a decline in the dominance of the U.S. dollar. As many of you probably know, the U.S. dollar has been very, very strong, especially this year. And we think that that could actually reverse. And one of the catalysts for that reversing could be central banks like Russia and China moving away from the dollar in the future. And then number ten to our list, which is an item we had on our list a number of years ago and we’ve brought back recently, is the potential for the breakup of the United Kingdom. And what we’re focusing on here is the potential for a referendum in Scotland, probably in the back half of 2023, where Scottish citizens may vote to leave the United Kingdom in favor of the European Union. So that’s our top ten, Ann. Happy to talk more about any of the various items that I just covered.

Ann: Thanks, John. I think the top three are so interesting because they’re interrelated in many ways. So maybe we can dig into the top three and how you’re thinking about them and maybe the interrelation between the three of them.

John: Sure. Yeah. So, the first one, the one we’ve called the surge in global inflation rates, that one in our minds is probably the most impactful for markets. It’s a concern we’ve had for many months now. And what we’re worried about there, and I think we’ve seen this play out over the first six months, is that the inflation rates in the U.S., 8%, 9%, you based on CPI (Consumer Price Index), are driving the Fed to aggressively hike rates. We just saw that this week with another 75-basis point increase by the Fed. And so, for this item, we’re thinking that we may need to start morphing this more towards a stagflation concern. Like I said, we’ve had it on here for a while as an inflation concern, but it’s played out very similar to how we thought it would, inflation leading to aggressive Fed rate hikes, aggressive Fed rate hikes now leading to a softening of the economy. And so, in our minds, stagflation, where you have limited growth or no growth in the U.S. economy but the inflation lingers, is probably we’re going to pivot on this item. And the reason we think this may be a high probability of occurring as the stagflationary environment, is that the Fed has the ability to impact the demand for certain things. But what is causing a lot of the inflation we’re seeing are supply shortages, shortages in energy. That’s leading the price spikes in energy prices. Shortages in food supplies leading the price hikes and scarcity of food. So, because of that, we think that the Fed may not have the impact that they’re necessarily expecting to have on the things that are generating the inflation. And as you said, this ties in very much so with our number two and number three items on the list.

Ann: Yeah, I think that’s so interesting because as I was talking to some of our investment teams and talking about energy in particular, it isn’t something that the Fed necessarily can control from a supply side. And I learned that OPEC (Organization of the Petroleum Exporting Countries) is producing 3 million barrels less capacity than is what is needed out there, OPEC+. So if you have Asian demand coming back post their zero-COVID policies, we know that energy demand is going to come back stronger than what it is today. And we know it’s already a problem. We haven’t seen much demand destruction. It’s going to be quite interesting to see how inflation with energy gets resolved in the short term.

John: I completely agree. And I think in the U.S. we’re seeing it as inflation. And what we have with our number three item, the idea of this acute recession in Europe, it goes beyond just inflation and then it goes to rationing and real scarcity of natural gas and of oil supplies. And I think the variable there that does tie things together is the Ukraine/Russia war where there are certain pipelines that go through Ukraine that have been shut in. There’s also then the pipelines that Russia controls and with the European Union taking a fairly negative stance towards Russia, we’ve seen Russia cut back on those supplies of natural gas and oil. And so that I think when we get into the winter months, my expectation is that the governments in Europe are going to lean towards making sure homes are heated with natural gas versus automotive plants or other industrial plants being powered. So, if they do get into the rationing, that I think could trigger a recession because if you have to idle automotive plants for two weeks so that people can continue to heat their homes, it’s going to certainly lead to a shortage in supply of auto materials and goods. And I think that could ultimately lead to a backup in in terms of the GDP (gross domestic product) and lead to that recession in Europe.

Ann: Yeah, very, very interesting, John. And again, correlates with some of the things that we’re hearing from bottom-up viewpoints of our investment teams, that the cycles are not as in sync as they used to be across the developing nations. And we’re going to have to watch things carefully. But that can bring opportunities to specific countries, especially as we look at the emerging markets.

John: Speaking of emerging markets, there may be some hope on our number two concern, which is this fear of civil unrest in the developing or the emerging market space because of food insecurity and food scarcity. And just recently the United Nations, Ukraine, and Russia did agree to allow some Ukrainian grain to be exported out. So, we’re going to monitor that closely. If it looks like that is happening, we could see some relief on the food price side and certainly on the food scarcity side. And that could reduce the risk that we’ll see unrest in some of these developing nations. If that doesn’t come true, the places that we’re most focused on are going to be places in Africa. So certainly Egypt, close to Africa, you would have Turkey. Turkey and Egypt are big importers of food supplies from both Ukraine and Russia. So those could be places that would experience some unrest if there was food scarcity. And then also there’s parts of Asia. Southeast Asia does import a lot of its food. And that could impact them if the grain supplies from Ukraine don’t make it there. But hopefully, with the deal that the United Nations has brokered, we’ll see some relief there. And if that happens, we’ll likely drop the number two concern on our list down the list or even remove it completely.

Ann: Yeah. And I think you said something really important there that we’re going to watch and listen carefully and we tend to pay a lot more attention to actions than words. So we will be watching carefully. So, thanks so much for that. And thanks for being here with us today and sharing your insights. It was a pleasure.

John: My pleasure, as well. Thank you for having me.

Ann: That wraps up this episode of On the Trading Desk®. If you’d like to read more market insights and investment perspectives from Allspring Global Investments, you can find them at our firm’s website, allspringglobal.com. T-o stay connected to On the Trading Desk® and listen to past and future episodes of the program, you can subscribe to the podcast on Apple Podcasts, Spotify, or wherever you get your podcasts. Until next time, I’m Ann Miletti and thanks for listening.

 

Disclosure: 100 basis points equals 1.00%. The Consumer Price Index (CPI) is a measure of the average change over time and the prices paid by urban consumers for a market basket of consumer goods and services. You cannot invest directly in an index.

CFA® and Chartered Financial Analyst® are trademarks owned by CFA Institute.

 

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