Stock and bond prices may seem random on any given day, but there is deeper meaning about the state of the world if you know where to look. Beneath the prospects of a company or the durability of the current economic cycle, there are important messages about the world order that US President Joe Biden's advisors should keep in mind as they prepare to update the national security strategy and launch the ritual drafting of his State of the Union speech.
Of course, financial markets don't really measure the world's economy in full, let alone all of its social and political dynamics. They also distort actual developments because of what former US Federal Reserve Chairman Alan Greenspan called "irrational exuberance," whether it's the euphoria around the first generation of dot-com companies at the turn of the millennium or the full-blown panic set off by the sudden appearance of a new and contagious virus two years ago. Still, persistent patterns in the $230 trillion sloshing around stock and bond markets do provide a numerical measure of what is going right and wrong in the world, much as a thermometer gives a rough gauge of a patient's health.
As we all struggle to label this confusing period with something more descriptive than the "post-post-Cold War" age, financial flows offer some surprisingly clear geopolitical outlines that should shape the president's agenda.
America still dominates. This is not entirely obvious amid the headlines of democracy on the brink since the US Capitol riot or faltering US leadership following the Kabul airport debacle. Biden's foreign priorities should highlight the fundamental truth that the world still has overwhelming confidence in US institutions. For all the latter's dysfunction, investors are still willing to pay 21 times next year's earnings for the companies in the S&P 500 Index, compared to 15 for Euro Stoxx and 18 for Japan's Nikkei. Low interest rates on US Treasury bonds reflect flows from around the world that see no better combination of high reward and low risk.
China continues to grow apart. The world's second largest economy still only represents about 4 percent of the MSCI All Country World Index, not least because of Beijing's lingering barriers to market access. Volatile stock returns have been a terrible proxy for China's amazing economic performance in part because the narrow mix of listed firms, spotty corporate disclosure, and rules restricting foreign investment. But the discrepancy in the index weighting actually reflects the larger truth that significant obstacles remain to the country's financial integration with global markets. In fact, even as China continues to grow larger and richer, it may depend more on its own resources and internal market demand than foreign investment and exports. Washington will continue to lay out its wish list for changes across a range of Beijing's policies, but the shape of markets reflects a sense that China will choose its own path.
Russia remains a regional power. Western warnings about the mounting threat of Russian troops massing on the Ukrainian border triggered a nearly 20 percent selloff in the Moscow Exchange last fall. Yet at the same time, the price of oil—a major Russian export—moved more on omicron fears than the chance that conflict might disrupt supplies. Since US-Russian negotiations ended in stalemate last week, Russian companies' share prices and the ruble have collapsed further still, even as the price of oil has surged. The crisis could still escalate with broader consequences for energy prices, but markets are telling the Biden administration that Russia's threat is serious but not global.
World leaders still aren't serious about climate change. While different schemes have taken root to put a price on carbon, 80 percent of global emissions remain unpriced. International Monetary Fund economists suggest rich countries need to charge at least $75 per ton to accelerate the transition to renewable energy, but the global average emissions price is $4. The president may call climate change an "existential crisis," but he will need more than soaring rhetoric to convince markets that change is coming. Change is also unlikely to come until markets start pricing it in.
Recent surges in energy prices have been blamed on underinvestment in oil and gas production, in part because of green pressures to cut back on fossil fuel production, and the day may be approaching when concerns about long-term supply drive prices sustainably higher. Current high crude prices, however, are driven much more by rapid demand recovery and OPEC's tight management of supply. Even sky-high natural gas prices in Europe are more related to weather and storage limitations than the possibility that gas production will fall short anytime soon.
The technology transformation has only just begun. Fears of rising interest rates in recent weeks triggered a sell-off in cryptocurrencies and technology stocks, but investors are still willing to pay a premium for Microsoft, Apple, and the like. These particular companies may or may not deliver, and many of the other current market darlings won't succeed, but technology valuations reflect an overwhelming sentiment that more disruption is at hand. This will mean more than new apps that support working from home. Rather, it's the combination of inexpensive sensors, cheap storage, ubiquitous mobile networks, and rapidly advancing artificial intelligence that will disrupt almost every business model.
Of course, it's still a physical world in which demand for commodities, industrial goods, and consumer products will dominate, but the most successful firms in all these sectors will be putting technology to better use. Data will be part of whatever label historians use to describe the next decade, and the markets are reminding the Biden administration that it needs a comprehensive plan that supports innovation, bolsters cybersecurity, ensures data privacy, and safeguards competition.
To be sure, markets are not always right about geopolitical risks. For all the time investors fret about the latest tensions in the Straits of Hormuz or on the Korean Peninsula, the odds of catastrophe are hard to measure and even harder to correlate with financial returns.
But when there are patterns that are durable and obvious, financial markets do reflect fundamental geopolitical truths. The Biden administration's international priorities shouldn't end with a review of the market's messages, but there are worse places to start.
Christopher Smart is the chief global strategist at Barings and the head of the Barings Investment Institute.
Disclaimer: This article first appeared on Foreign Policy, and is published by special syndication arrangement.