Merlin Weekly Macro: Markets sanguine even as geopolitical risks rise

The geopolitical subjects of which we have been writing in these columns over the past six weeks or so are what can be best described as “dynamic”. For which read, in flux and unresolved.

French farce

Take France: September 9^th, Prime Minister Beyrou (the fourth French PM in 15 months!) resigns, unable to deliver a fiscally responsible budget; September 9^th, Sebastian Lecornu is appointed prime minister; October 6^th, Prime Minister Lecornu resigns, unable to deliver a fiscally responsible budget; October 10^th, Sebastian Lecornu is reappointed prime minister, his precondition for government stability and his continued leadership being that President Macron’s pension reform, the heart of the fiscally responsible budget, is “paused” until after the presidential election. At the time of going to press, Lecornu has narrowly survived a new no-confidence vote led by the hard-left who never wanted welfare or pension reforms in the first place and now have their wish (are you still following? Do keep up at the back). Whatever comes to pass (and Lecornu’s premiership still hangs on a thread) this political pantomime is going to run and run until either Macron’s term expires in April 2027 or, given there is no longer any point to his presidency, he admits defeat and capitulates. France’s government is completely dysfunctional; however, France as a state remains fully functioning although society has febrile undertones and elements have a fondness for casual rioting especially at weekends. How long a functioning state can continue despite a dysfunctional government is an open question.

Thanks to its fiscal incontinence and the political paralysis ensuring meaningful economic repair is nigh on impossible, even if Lecornu manages to maintain a policy of sorts acceptable to both the hard-left and the hard-right when there is precious little in the middle, France’s economic problems are not going away. French financial life support is maintained by the ECB’s anti-fragmentation stability mechanism: France might be paying 30% more than Germany to service its debt but the yield spread on French bonds over their German equivalents has been almost rock-solid throughout the long crisis. The concept of “bond vigilantism”, where free markets mark governments’ cards by determining the cost of capital according to the idiosyncratic risk (as happened graphically in the UK during the Truss/Kwarteng car-crash budget in October 2022, for example), does not apply. Through the manipulation by the central bank, stability is maintained (good); but the flip-side is that there is no independent financial stick available with which to beat the French or any other delinquent eurozone government into addressing the underlying problem (bad). Brussels has very little influence either, indeed its interference only fans right-wing, anti-EU nationalist sentiment. While all appears of little concern as measured through the usual investment barometers of bond yields, equity indices and exchange rates, the reality is it is a case of who’s kidding whom. 

Gaza: reconciliation?

Then there is Gaza. Palestinians are going back to the Strip and the return of hostages both living and dead is under way. But no sooner had Air Force One’s undercarriage retracted as President Trump returned to the US after his whistlestop ceasefire celebration, than violent internecine strife had broken out between competing, warring clans and Hamas for control of that benighted enclave. Phase Two, the transitional government and security of the Strip is yet to be confronted with the Mike Tyson test: “everyone has a plan until they get punched in the mouth”. The transitional plan may not survive first contact. Time will tell.

But however horrific the humanitarian catastrophe, the situation in the Middle East is of little direct concern to hard-nosed investors (they consider themselves pragmatists): it is weighed up in the calculation of broader contextual risk, but to the minimal extent if any it affects the economic or financial outlook, then context is all it is. Markets can appear callous and cynical that way.

Where the Middle Eastern situation might have ramifications is if Trump gains an appetite for what might be termed “muscular diplomacy”: the threat and/or application of hard power and the agency of the military to effect a desired outcome (in different times governments used to send a gunboat; today you drop a “MOP” or threaten to “rain hell”). Having seen himself as successful bringing about some form of limited reconciliation in the Israeli-Palestinian conflict, Trump may opt to apply similar means to bringing about an end to the Russo-Ukrainian war. To state the obvious, the nuclear-armed Russian state and the Hamas militia are very different beasts. Talk is that Trump is prepared to up the ante in Ukraine, furnishing President Zelensky with the venerable but effective Tomahawk long-range cruise missile system capable of attacking key military and infrastructure installations deep inside Russia. Risking state-on-state conflict between NATO and Russia would be a big deal. 

China: time to get real, folks!

Finally, we return to last week’s subject: China. The UK political row rumbles on about the failed espionage prosecution. Away from the obfuscation of Whitehall it is tempting to think that these miscellaneous ramblings have the power to influence the White House; if not, how coincidental was it that within six hours of our publicly throwing down the gauntlet to Trump about his dithering over China in relation to Ukraine in last week’s Merlin Macro, than he announced the threat of 100% tariffs on all Chinese goods into the US! He subsequently linked the revenue stream to a potential war chest to fund the rebuilding of Ukraine.

The reality is more prosaic. It was in response to the Chinese imposition of export controls on rare-earth elements and minerals so critical to the global electronics industry (with all the wide-ranging industrial, commercial and military applications that are affected) and the net-zero revolution. With accusations flying back and forth, both sides have gradually begun partial backtracking ahead of the Asia Pacific Economic Cooperation talks later this month in South Korea and the important bilateral US/Sino trade meeting attached to the event.

But notwithstanding the tactical outcome of those talks, the bigger geostrategic picture is one of a colossal clash of the titans, each in their own long-term pursuit of global dominance. This is where Trump’s “America First” and “Make America Great Again” ideology meets the explicit Chinese leadership’s own intentions for a New World Order head-on. If Xi Jinping’s ambitions for global supremacy are a direct threat to the existing US hegemon, Trump’s equally explicit desire for America to be the “most dominant civilisation the world has ever seen” is not only his own credo but bound to be seen as both a threat and a provocation in Beijing. There cannot be two top dogs: the preoccupation is with who wins (and therefore who loses) and what is the collateral damage to everyone else as they slug it out.

US Treasury Secretary Scott Bessent was quick to accuse China of what amounted to economic piracy: holding the world to ransom through the restrictions placed on trade volumes in those critical elements and minerals, while simultaneously “bringing down the world economy”. Bessent sees it as a defensive smokescreen for the CCP to hide behind to disguise a Chinese economy which he believes is in trouble. China couched it as a tit-for-tat response to US restrictions on soya sales.

In this Great Game of geostrategic poker, who has the better hand? There are many factors at work. The US is self-sufficient in oil; China relies almost entirely on imports for oil and gas (but still has coal, has added as much solar capacity in the last year as the rest of the world combined, and has nuclear). The US is almost entirely deficient in rare-earth minerals, ores and elements and is heavily reliant on imports (it is why Trump is so preoccupied with extracting mining rights from Ukraine as part of any peace plan, also attempting to secure control of Greenland with all its untapped mineral wealth); China on the other hand has significant control globally over sources and/or supply chains of such materials. The US dominates global tech development for now, but China is innovating fast; were China successfully to “recover” Taiwan (a stated aim) with its semiconductor industry intact, it would have an unrivalled combined three-quarter share of global chip supply, including a near-monopoly on the most advanced types with all the obvious consequences for global industry, commerce and the military. Today, data is power: in the US it is predominantly harvested and mined by big, global tech companies; in China, all the data ‘collected’ by whatever means from anywhere in the world is in the ownership of the Chinese Communist Party which uses it ruthlessly to push its own national interest. Politically, Xi has the facility to remain in office until he is deposed, drops or is incapable; Trump is time-expired in January 2029 but in the meantime has an intermediate appointment with the electorate in less than 13 months when all the House and a third of the Senate seats will be contested in the November 2026 Congressional mid-terms. Xi is playing the long game; Trump is a man in a hurry.

The investment perspective

As well as trade, the other battlegrounds (or are they weapons, or both?) are their respective currencies, their national bonds and the ability for them to become manipulable, and global settlement systems. The stakes could not be higher.

Markets react to short-term stimuli such as economic data, trade embargoes or new tariffs being imposed. What they have not yet fully begun to appreciate is the strategic direction of travel and the build-up of tensions as the geopolitical tectonic plates shift. When the pressure is eventually released (usually in response to a single catalyst) it will be rather too late to begin wondering what happened. The evidence is mounting already; the question is, how do markets begin to re-price risk to take account of it? Despite all the warnings from the IMF, the Bank of England and Jamie Dimon, the doyen of JP Morgan, that equities are frothy, the majority of investors remain sanguine. In fixed income, bond yields have moderated as markets anticipate rate cuts amid trade tensions (dipping below 4%, the US 10-Year Treasury yield is its lowest since September 2024); bond prices travel in the opposite direction to their yields. But among all the sophisticated modern instruments, perhaps it is the oldest and least sophisticated of all that points the way: as financial protection, the gold price has been strong all this year, remarkably so since late-August. The price has more than doubled since the beginning of 2024 and is up over 60% year-to-date and daily testing new all-time highs; possibly it too is frothy short-term but the general sentiment it betrays of greater long-term risks seems sound.

All the Jupiter Merlin Portfolios have a weighting in physical gold, ranging from 3% in Jupiter Merlin Worldwide to 4.6% in Jupiter Merlin Conservative Select. It has been a significant contributor to performance this year. 

The Jupiter Merlin Portfolios are long-term investments; they are certainly not immune from market volatility, but they are expected to be less volatile over time, commensurate with the risk tolerance of each. With liquidity uppermost in our mind, we seek to invest in funds run by experienced managers with a blend of styles but who share our core philosophy of trying to capture good performance in buoyant markets while minimising as far as possible the risk of losses in more challenging conditions.