Keep your finger on the geopolitical pulse and stand to reap huge rewards
History suggests that geopolitical events can offer investment opportunities worth exploiting
Geopolitical risk stands out as one of the uncertainties facing global financial markets in 2020.
Recent events in the Middle East, including the desperate race by Syrian refugees to outrun the regime’s offensive, have highlighted these risks. However, history suggests that geopolitical events can produce exciting investment opportunities well worth exploiting.
To reap the benefits of timely, tactical adjustments, the challenge remains to identify which geopolitical risks will affect economic and market outcomes and which may already be priced into the market. The economic impacts of geopolitical events are as difficult to predict as the events themselves.
While the media tends to draw attention to events causing uncertainty, publicised events, such as a Brexit or the US-China trade war (which has subsequently been ameliorated through the signing of a “phase one” deal), are often already priced into the market, reducing risk from an investment perspective.
Despite the noise surrounding Brexit, it may serve as an attractive investment opportunity to increase exposure to the pound and to undervalued UK assets, both of which have the potential to recover in the long term. Post-election UK assets have outperformed as some of the uncertainty around the UK government and Brexit has lifted.
Investors may need to dig deeper and consider geopolitical events that are going by unnoticed. As an example, with all the focus on the US-China trade war, investors may not have noticed a second trade war that is gathering steam between South Korea and Japan. Powered by wartime damages from the World War 2 and rising anti-Japanese sentiment in Korea, it threatens to disrupt global supply chains.
This follows stringent export controls to Korea exerted by Japan on crucial materials required in the manufacture of memory chips used in smartphones and personal computers. Another example is Japanese beer exports to South Korea, which fell by a staggering 99.9% in September last year.
In the current global environment of heightened geopolitical risk, it may be a prudent approach to hold some allocation to cash, providing the necessary dry powder to buy into lower valuations resulting from geopolitical events. This approach is supported by the results of a historical geopolitical risk review conducted by BCA Research.
Dating back to 1956, their research shows an average decline resulting from geopolitical events over time of about 10%. This decline is in line with the technical definition of a market correction, which is expressed as a decline of at least 10% but no more than 20%, within a period of about three months. Further research revealed that after 12 months, the average recovery from geopolitical losses over time has been about 10%.
Rather than panic-sell in the aftermath of a geopolitical event, such research backs an active, tactical asset allocation strategy where risk exposures are increased, should post-event valuations support this. For example, the Gulf war, which took place in August 1990, resulted in the market declining nearly 20%, but from this level, global markets recovered and were up about 10% just 12 months later. A similar scenario with Brexit. The FTSE 100 sold off by 5.8% on the day of the vote, but from this level the index was up 15.8% over the ensuing 12 months.
There are a number of potential geopolitical events, concentrated primarily in the Far East, that investors should be aware of as they could lead to a surge in risk aversion, causing volatility for global financial markets. After Taiwan’s general election held on January 11, 2020, incumbent president Tsai Ing-wen was declared victor, with 7.8-million votes. Her election could harden Beijing’s Taiwan policy, leading to potential conflict between Beijing and Washington.
Meanwhile, North Korea is threatening to resume nuclear tests and pressure is growing on the Trump administration to take a hard line towards Pyongyang. Stability on the Korean peninsula may face new challenges this year. Any renewed Sino-US clash will be negative news for global markets. The recent signing of a phase one trade agreement provided some relief for equity markets, which rose to a record high in the immediate aftermath.
Most recently, the outbreak of the coronavirus has dominated headlines and led to elevated market volatility. It seems eerily similar to the late 2002 outbreak of severe acute respiratory syndrome (Sars), which also originated in China. While past events suggest the impact of the coronavirus will prove temporary and short lived, the potential for an economic slowdown over the short term exists due to the outsize precautions taken by the Chinese government. The test will be whether there is a sustained disruption to the daily lives of consumers and businesses across the globe.
Lastly, US’s domestic politics could also be a source of potential shock to markets. Though Bernie Sanders’s popularity seems to be waning and Joe Biden’s rising, Sanders represents the radical Left and his economic policy platforms are likely to be bearish for equity markets if his star rises again.
Certainly, geopolitics are likely to feature as a driver of markets in 2020. A sound knowledge of the geopolitical landscape should help investors make informed decisions that align with their specific, long-term purpose and objectives.
Managing investment strategies for geopolitical risk remains a great challenge due to the difficulty in predicting future events and their long-term global impact, but the ability to be dynamic and flexible may provide investors with unexpected buying opportunities that can realise long-term rewards.
• Geldenhuys is SA client portfolio manager for Stonehage Fleming