John Moninger, head of U.S. Distribution at Allspring, speaks with John Hockers, co-head of the Investment Analytics team, about the prominent global risks that are top of mind for him and his team and how these themes are being used for investment risk management across all of the Allspring investment teams.
John Hockers: We create the Market Risk Monitor. What are those macro risks that could derail all of the best intentions? It forces us to really sharpen our pencils and get down to what we really think our teams should be worried about.
John Moninger: That’s John Hockers, co-head of the Investment Analytics team here at Allspring Global Investments. I’m John Moninger, head of U.S. Distribution at Allspring, and you’re listening to On The Trading Desk®. Today, we’re talking about prominent global risks that are top of mind for John and his team and how these themes are being used for investment risk management across all of the Allspring investment teams. Thanks for being here, John.
John Hockers: It’s great to be here today.
John Moninger: John, could you start with an introduction of your role here at Allspring and what we’re doing to produce and help clients navigate risks?
John Hockers: Yeah, absolutely. So, Investment Analytics is an umbrella organization that has 10 different functional areas within it that spans everything from equity analytics to quantitative insights and data science. We really have two main mandates. One is to provide analytics back to our teams to help them manage their portfolios and manage risk in their portfolios. And then, the second mandate is for us to provide some type of credible challenge to the risk-taking that’s occurring in those portfolios. One of those things that we create is something we call the Market Risk Monitor. It thinks about what are those things in the world, those macro risks, that could derail all of the best intentions of our portfolio management teams? So, it forces us to really sharpen our pencils and get down to what we really think our team should be worried about.
John Moninger: Where would I find this Market Risk Monitor if I’m a client looking for it? Where would I go?
John Hockers: We publish it every month out to allspringglobal.com. It’s designed to be a top 10 list. And I think people really like top 10 lists, right? They’re short, they’re concise, and people can kind of debate, “Well, should that be number 1 or should that be number 2?” [You can find the Market Risk Monitor here.]
John Moninger: Why don’t we dig in a little bit? If you think about some of the biggest topics that are out there today, given the recent conflict in the Middle East, the ongoing developments in Russia and Ukraine, and certainly some of the nervousness we have about what could happen in China, how do you see those risks playing out? And what have you written about so far in the monitor?
John Hockers: Yeah, so, obviously, I think like most people in the world, it’s really been hard to watch some of the events that are occurring in the Middle East and our hearts go out to everyone who is there and dealing with it. But what we have to do from our perspective is put our analytical hats on and say, OK, how does this impact our investments? How does this impact the risk in our portfolios? When we do that, when we look at, say, the Israeli conflict and what’s happening in Gaza and in the region, we see that as contained from an investment risk perspective, unless it expands into the Persian Gulf, the oil-producing regions. And there, I think what happens then is if you have a disruption in oil supply that comes through the Middle East, you’ll see a dramatic move higher in energy prices—particularly oil, but also liquefied natural gas. And that’s where we think it really starts to play into the markets—European equity and fixed income markets and U.S. and Asian equity and fixed income markets. So, if you think about the conflict today, you have the Iranian regime there using proxies to instigate things. They started that in Iraq. They’ve been doing it in Yemen for a while with the Saudis. And now we’re seeing that in the Israel area with Hamas and Hezbollah. I think if the conflict becomes a direct conflict between Israel and Iran or if the U.S. enters the conflict and is engaged with Iran, I think that’s where you’re going to see that significant movement in the oil markets. Another concern we’re thinking about is the conflict between Russia and Ukraine. What we worry about with Russia and Ukraine is that the war could expand to the other parts of Eastern Europe. It could expand to the point where NATO gets involved. Another part of that is this concept of environmental terrorism. We saw this a little bit with the Russian side of things where they destroyed a dam and that dam flooded an area in Ukraine. And the reason they did that is to try to stop the advance of Ukrainian troops and could actually see the Russians using either nuclear power plants or nuclear weapons to create radioactive areas that try to block Ukrainian troop movements. That’s, like I said, probably the most extreme of the extreme, but that’s something that we’re thinking about when we think about Russia-Ukraine and how this could play out. And then, of course, I think many people have, for years now, been worried about China and Taiwan. We have that on our list, as well. We still have it as a low probability event over the next 12 months. So, we think it’s less than a 10% probability that China would move on Taiwan over the next 12 months. But that, from an event perspective, is certainly one that would make it into the history books. It’s one that we think would lead to huge dislocations in markets around the world. You would obviously have the markets in Hong Kong, China, and Taiwan that would be severely impacted. But then you would have markets in the U.S. that would be impacted. And there, we worry about the information technology sector. Taiwan is a hub for semiconductor manufacturing. Many companies rely on Taiwan for those semiconductor chips. So, if you have a conflict that breaks out there and the flow of semiconductors is disrupted, you’re going to have supply chain issues probably that are worse than what we saw during COVID.
John Moninger: Can you go through some of the main risks to both the U.S. and global economies that you and the Investment Analytic teams are monitoring?
John Hockers: On the economic front, we’re thinking about three key items here and two of them are really pretty tightly related. So, let me jump right into the first one, and that’s the prospect for a U.S. government shutdown. So, we’ve seen a little bit of chaos here in the U.S. in terms of our politics. If you think about the House of Representatives, Speaker McCarthy was removed as speaker—something that we’ve never seen happen before. And as we’re navigating through this, we think that increases the probability that the U.S. won’t have government funding on November 17. And if that’s the case, then we’re setting ourselves up for a potentially nasty prolonged government shutdown that goes through Thanksgiving and maybe makes its way to Christmas. And the reason I bring that up is if that happens, we think holiday travel will be impacted. We think holiday retail sales could be impacted. And that could be that proverbial straw that breaks the camel’s back in terms of the global economy. And that gets us to number two, which is this idea of a global recession, right? We think that China’s struggling today with the real estate markets. Europe is always susceptible to spikes in energy prices. And then on the U.S. side, I think what we’re seeing here is if we have a government shutdown, that could push us over the edge and maybe tip us into a recession. And because we’re already dealing with a lot in the U.S. in terms of higher interest rates, the Fed has been moving rates higher for a considerable amount of time here. The “higher for longer” concept is in play. Higher interest rates make it harder for companies to invest, harder for companies to finance their debt. And so, you have that narrative. You have the COVID stimulus starting to wear off. You have the savings of individuals starting to be spent down. And one of the things I’ve been thinking about is this concept of a revenge travel. People were stuck in their houses for a long time with COVID. And then this past summer, I think they wanted to travel with a passion. They wanted to go to Europe. They wanted to do other things in the United States. And what they did is they spent down a lot of their savings during the summer. They now might need to pay for that, right? And if we go into a government shutdown, that could set up a situation where the U.S. could tip into recession in 2024. And then, the third item on that economic front is the commercial real estate market here really being in a tough situation. And when we think about that, this is probably only the second or third inning of a nine-inning baseball game here. And again, this goes back to COVID. When we think about COVID, it really changed the mindset of people being able to work from home, work virtually, and companies starting to rethink their office space and their office space needs. And we’re seeing vacancy rates in places like New York and San Francisco move higher. So, as we deal with higher interest rates and refinancing debt at higher and higher levels, it’s basically more money going out the door and less money coming in. And we’re worried that that could lead to defaults in the real estate sector.
John Moninger: So, John, what are the wildcards or any of the final risks that are keeping you up at night and your team? And how do you think about that for not only 2023 but also beyond?
John Hockers: Yeah, great question. One of our wildcards is the potential for another global pandemic There is another virus out there. It’s actually the bird flu. It’s the H5N1 virus. And if you look at some of the World Health Organization’s analysis out there, you’re hearing more about how the bird flu has become widespread in wild birds. Now, what does that mean for humans, right? It’s not normally a virus that jumps over to the human side of things. But if it were, it could be really quite ugly. Of all items on our list, it’s the one that I worry about, in some ways, the most because our ability to deal with it is much more constrained. And so, obviously, we could look for vaccines, but those vaccines take a while. And for those who don’t know about the human side of the bird flu, humans have contacted it directly from wild birds, but it hasn’t spread from human to human. But when humans do contact it right now, the mortality rates are incredibly high, north of 50%. And so that is what worries me. If you have a virus with that high of a mortality rate, it really will shut down the economy, probably more so than what COVID did. A couple of others, maybe less extreme, less scary but more likely to happen, one is the return of bond vigilantes in the U.S. This is a term that was coined many years ago. And it’s this concept that investors in Treasury securities may protest and decide not to buy them. And so, one of the items we’re watching is the potential for us to get to an auction, a Treasury auction, and nobody shows up to buy it. And that could lead to what I like to think of as almost like a bond market flash-crash, right? Where the bottom falls out of the bond market very quickly, you see yield spike up 50 basis points, 100 basis points because of a failed auction. So that’s something we’re keeping an eye on. We’ve certainly seen a lot of movement higher in the 10-year and the 30-year yields and you could see more of a discontinuity event or a continuous spike up with a failed auction. And then, another item we’re looking at is higher interest rates in Japan. And one of the things that has been going on in Japan for decades is they’ve been managing their yield curve with a policy that basically fixed the long end of the curve and the short end of the curve at specific interest rates. And the Japanese central bank has started to ease up on that and allow more flexibility in how Japanese government bonds, or JGBs, will trade. And one of the things I always worry about is when you go from a regime where a security had very low volatility for decades—risk models see that and they see low volatility—but if that regime changes to a much higher volatility regime, people are sometimes caught off guard and unexpected. So, we’re keeping a close eye on what’s happening in the Japanese market and how JGBs might start to move from a volatility perspective. And that could surprise a few market participants if you start seeing more U.S. Treasury like volatility in the Japanese long rates.
John Moninger: Well, there’s a lot there, John. As a reminder to our listeners, on our website, you can go to allspringglobal.com, Insights, and then you can click on the Market Risk Monitor updates every month. I know you have a lot of places to get information. There’s a tremendous amount of information out there today, whether on the internet or otherwise. But we appreciate you turning your attention to Allspring for insights and what’s going on in the markets, in the economy, and the risks that are associated with it. John, thanks to you and your team for all the great work and certainly thanks for spending time with us today to share your insights.
John Hockers: It was a pleasure to be here.
John Moninger: And for all our listeners, thank you for joining us here On the Trading Desk®.
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Disclosure: 100 basis points equals 1.00%.