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Geopolitical Risks Increase Uncertainty Around Policy

| April 11, 2017
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Geopolitical Risks Increase Uncertainty Around Policy

In our most recent market outlook, Transitioning to a Faster Growth Economy, we noted that we are generally constructive on financial markets, but our optimism is tempered by the increasing uncertainty around the timing and impact of potential drivers of growth going forward. In particular, we noted uncertainty around policy decisions, both foreign policy and Fed policy, would be influential to market returns. Over the past 24 hours, we have seen two examples of potential policy events likely to impact markets – President Trump’s decision to launch missiles at Syria and the disappointing March employment report. 

Starting with foreign policy, Trump ordered a missile strike on a Syrian air force base which is believed to be the base where Syria launched a chemical weapon attack. While the strike was limited to this one base, an escalation of this conflict increases the possibility of foreign policy missteps that we highlighted in the risk section of the outlook. Russia, who has been an ally of the Syrian government, has called this strike an act of aggression that violates international law. If the Trump administration does not articulate a clear strategy regarding this conflict, the ramifications could be adverse for global financial markets.

Also in respect to foreign policy, Trump is currently meeting with Chinese President Xi Jinping. Compounding the implications of this situation, the Chinese have sided with Russia and Syria in this conflict. In addition, the United States has wanted more assistance from China in dealing with their neighbor North Korea. North Korea has been testing their missile capabilities and has been able to launch them at increasingly further distances. This issue is arguably more concerning than the Syrian crisis as South Korea shares a peninsula with North Korea, which has nuclear weapons aspirations. We expect financial markets to carefully watch Trump’s foreign policies.

Another cue we highlighted in our most recent outlook was the potential impact of Fed policy on market returns. Today, in its monthly reading of the labor market, the government reported that the U.S. economy created only 98,000 new jobs in March, marking the smallest gain in nearly a year. This report is important to investors as it generally represents one of the first looks at the domestic economy in the prior month. While bad weather likely impacted this report to some extent, the overall result was disappointing and below the consensus forecast. Despite this disappointing report, investor reaction has been more positive than we anticipated. We suspect the equity markets are pointing to the fact that weakness in job growth may give the Federal Reserve reason to pause on its next increase in U.S. interest rates. 

Despite the potentially market-jarring overnight news surrounding U.S. military action in Syria and the consequential impact on Russian-American relations, along with the disappointing March jobs report, investor reaction has been somewhat positive. Not surprisingly after the missile strike news, equity market futures initially sold off sharply while safe-haven assets such as gold and Treasuries were positive. However, after the payroll report which increased the chances, albeit slightly, that the Fed may pause its interest rate normalization policy, U.S. equity markets opened flat to slightly higher. Investors are balancing these recent events with recent positive economic data and a hopefully optimistic beginning to the corporate earnings season. 

Recent events and data remind us that policy risks continue to persist. From a portfolio investing standpoint, we continue to recommend a bias to domestic securities as a core position. However, to mitigate unforeseen volatility, we believe it is prudent to retain an allocation to alternative investments that have low correlations to traditional core investments and remain well diversified among asset classes. From an implementation perspective, we prefer managers with flexible investment styles that provide the discretion and ability to move nimbly within their mandates in the face of this changing economic environment that we foresee. 

This report is created by Cetera Investment Management LLC 

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