The macro headwinds that geopolitical risks may stir up

As tensions in the Middle East escalate, investors are reevaluating their portfolio allocations to offset any geopolitical risks. Brandywine Global Portfolio Manager John McClain joins the discussion to provide insights on navigating this environment while crude oil prices (CL=F, BZ=F) are also slowly ticking up Friday.

McClain highlights three key factors that investors should consider from a "macro perspective." Firstly, he sees "a lot of upside potential" for oil prices, driven by a supply-demand dynamic. Secondly, McClain emphasizes the importance of interest rates, calling the US Treasury market "a safe haven," although he cautioned that investors "have to be careful" with their positioning along the yield curve. Lastly, he highlights the "US exceptionalism" in the foreign exchange (FX) market with the US dollar benefiting from being "the only place to go for AI."

When it comes to portfolio construction, McClain advises investors to focus on "what industries are driving" the particular region they are invested in. He underscores the crucial role played by central banks and their monetary policies, which can significantly impact portfolio performance.

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This post was written by Angel Smith

Video transcript

BRAD SMITH: Oil price is higher this morning following Israel's retaliatory attack on Iran. Oil prices have jumped over 15% so far this year over fears of wider escalation in the Middle East. But amid this geopolitical conflict, How should you be evaluating your portfolio? John McClain Brandywine Global Portfolio Manager joins us now. John, thanks so much for taking the time here with us this morning. First and foremost, I mean, this is clearly in the bucket of exogenous threats, those events that you can't predict will take place. You just have to be able to react to them or have a strategy that already has this baked in into the risk assessment. So how can people exogenous threat proof their portfolio?

JOHN MCCLAIN: Well, there's no surefire way I think is the answer certainly. But from a macro perspective, we're looking at three things. And you were touching upon it earlier. Oil absolutely is something that you should be looking at. We've come off a bit during the day and a bit over the past few weeks, but we think there's a lot of reasons for upside potential in the commodity, not just the geopolitical, it's really about supply and demand right now. And supply, look, the US economy is stronger than we all thought. It's plugging along here. You've got countries like India, which is going to be one of the largest, you know, incremental consumers doing quite well right now.

And then on the demand side, you have issues with potential sanctions around Iran, Venezuela, OPEC holding production cuts. So we look and say, What will we do to express bullish opinion on oil? Well, we like Canada. We think it's a swing producer. It's picking up some of the production from OPEC cuts. On the large-cap side, you look at a Canadian natural. On the mid-cap side, you look at something like a MEG Energy. And from there, you'd be looking at rates as another thing. And the front end of the US is absolutely a safe haven. It's great carry. Why are you going to worry about risk when you can get 5% from US treasuries? But the problem is that you really have to be careful in terms about picking where you want to be on the curve.

So the front end makes sense to us. The back end, the tens and thirties can be pretty tricky because of the uptick that we're going to see in treasury supply and the lack of fiscal discipline that we're seeing. And then finally, we'd be thinking about FX. And right now it's US exceptionalism. The only place to go for AI is the US. The US economy is doing much better than other developed economies. Asia and Europe potentially much more impacted from a conflict perspective on geographic proximity in terms of trading goods. That leads us to believe that the US exceptionalism piece of the dollar smile's in place.

BRAD SMITH: You want to go further into that Europe and Asia portion as well. Because for some investors, for some who are looking across their portfolio out there, they may be thinking about the globalized element of their portfolio. And Europe and Asia will play a pretty significant part of that in some instances too. So how do you then go about evaluating those regions aptly?

JOHN MCCLAIN: Well, you know, you got to think about the construction of what industries are driving. You know, in the US, it's certainly a tech perspective. Outside of the US, you're running different sector exposures here, and also you have to be thinking about, What are the central banks doing? What is the BOJ doing relative to the ECB and the BoE? From our perspective, you know, we think the ECB and the BoE are both going to be in a cutting cycle before the Fed, and so that's going to put pressure on their currencies. The BOJ is a bit of a wild card here, so I think you have to be paying attention to the signals that they're sending.

BRAD SMITH: And then just lastly, you're also-- and you mentioned this in your notes to us, you're also monitoring the flow of funds that had remained constructive until the week ending April 17th and some of the outflows there. Just walk us through that dynamic that you're tracking.

JOHN MCCLAIN: Well, that's about US-fixed income relative to equities. And certainly when we're thinking about investor positioning on more of a micro level, we would say fade US equities and buy high yields. Large cap equities are heavily exposed to international marketplaces where the US is much more domestic. And as we said, we like the dollar, we like the US economy, we think it's a good place to be. We are absolutely paying attention to, again, supply and demand. The technical is very strong in US-fixed income right now. We have individuals really shifting a lot of their capital away from equity into fixed income. But more importantly, we have your pensions, endowments, and sovereign wealth funds shifting away from equity and into fixed income.

Because when you can hit your 7%, 8%, 9% hurdle rate in fixed income and doing it with a safer instrument and less volatility, we see the large institutional allocators continuing to put capital into our marketplace. We had a bit of a hiccup, and certainly that makes sense over the past week with the geopolitical tensions with the tight spread levels that we've seen in the asset class. But we think it's just that, a hiccup.

BRAD SMITH: John McClain Brandywine Global Portfolio Manager. Thanks so much for taking the time this morning, John. Appreciate it.