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Geopolitical angst more a market feature than shock

Even with two geopolitically risky wars raging and a series of critical elections next year, there’s little in annual outlooks suggesting investors should head for the bunkers.

Judging by a torrent of 2024 investment advisories already filling inboxes, anxious geopolitics – turbulent for over five years amid trade wars, a pandemic, Russia’s invasion of Ukraine and the Israel-Hamas war – is now almost considered a constant to be navigated rather than a reason to go to ground.

Even on some of the dominant elections of the year ahead – in the United States, India, Taiwan, Mexico and possibly Britain – there’s a sense the range of outcomes are ‘known unknowns’.

The risks are not downplayed – and the bar for disruptive surprises is clearly lower than for decades. Rather, asset managers increasingly position these as now a feature of global investing choices rather than all-consuming shocks per se.

To be sure, Bank of America’s most recent monthly fund manager survey – perhaps because polling took place as the Gaza conflict unfolded – found worsening geopolitics the biggest ‘tail risk’ for the first time since Russia-Ukraine dominated in April 2022.

Likely for the same reason, geopolitical risk monitors are at their highest in over 18 months too.

But if – as with the Ukraine fallout – spiking energy prices are seen as the main economic risk from a Middle East conflagration, then that’s proving well wide of the mark to date.

After a brief jump following the attacks on Israel last month, crude oil prices have already reversed all of their gains and are plumbing their lowest levels since July – down 23% in six weeks and tracking year-on-year declines of 14%.

And while it’s tempting to say the conflict is being downplayed as an energy risk, the swooning oil price is as much to do with stepped up U.S. shale production and Washington’s intensified push on domestic energy security. Ebbing demand from a Chinese economy hobbled by property busts and a foreign investment withdrawal due to U.S. investment curbs also hurts.

Geopolitics is indeed playing a role, just not in the way it’s typically mapped.

Another temptation for those anxious about the state of world politics is to seek traditional ‘safe’ assets like U.S. Treasury bonds as a haven. And yet that would have been a bum steer since the Ukraine invasion as central banks scrambled to douse inflation seeded by the oil and gas price spikes then.

Still, after three dire years, sovereign bonds are widely tipped again to be an investment of choice next year – not least as fears of a mild cyclical recession and disinflation allow interest rates to reverse at last.

But far from seeing falling bond yields as a retreat to safety, the drop in borrowing rates is now correlated heavily with riskier bets in stocks – evidenced once again in a 10% rally on Wall St this month as long-term borrowing costs fell almost half a percentage point on rate cut hopes.

An uncertain dance between soft economic landings and recession next year may dictate where you invest on the corporate credit spectrum, but perhaps the biggest choices are now which country or region you choose.

If U.S.-China tensions ramp up again over Taiwan, for example, maybe technology stocks get side-swiped as chips become the oil of that standoff. And yet U.S. tech stocks have been the star performers all this year even as the two superpowers traded brickbats and curbs, and the related ‘chip wars’ led instead to domestic investment booms and digital security pushes.

Once again, geopolitics at work – but not in easily predictable ways.

As to next year’s White House and congressional races, the outcome is up in the air as incumbent President Joe Biden and his predecessor Donald Trump are neck and neck in many polls.

While most investors would see Trump’s return as most jarring to the global status quo, neither of the expected candidates – for different reasons maybe – would be expected to neutralise geopolitical anxiety at large.

UBS Global Wealth Management points out that excluding the unrelated banking crash of 2008, Wall St stocks have gained more than 13% on average in presidential election years since 1928 – with best and worst outcomes in years with wins for both parties.

“We recommend investors express their political preferences at the polls and not with their portfolios,” it said, adding more generally that clients should “prepare for bouts of politically driven volatility and consider hedges”.

But then it still expects healthy gains for both stocks and bonds over the 12 months.

What’s more, volatility bouts seem strikingly mild so far.

The VIX index of U.S. stock volatility is currently five points below its historic average 19 – and even July VIX futures hover on that mean.

After another rough year, bond volatility is indeed above 20-year averages – but it’s already almost half the peaks of March’s banking wobble.

While that split may underline many funds’ preference for bonds over equities, not all forecasters are convinced.

Barclays thinks equities will outperform fixed income next year. “The downside risks to the world economy have diminished greatly,” it reckons.
With such political uncertainty afoot, maybe it’s just punch-drunk market pricing itself that packs the biggest risk.

Melissa Brown at risk consultancy Axioma fears a ‘triple whammy’ of low volatility, low trading volume and narrow leadership of tech-flattered stock index gains – along with high stock-to-stock correlations that reveal both macro concerns and investor confusion that make it hard to safely diversify.

If interest rates don’t come down quickly to tempt out a record $1.4 trillion that’s gravitated to cash funds this year, then persistent geopolitical stress and an election year raises the bar for all investment – due largely to its impact on public debt.

“There is a political desire to maintain high budget deficits and government intervention,” said Andrew McCaffery, Global CIO at Fidelity, whose base case is recession in 2024. “Markets will start to exert a greater price for that spending. We are going to be talking about the cost of capital a lot in 2024, not just for corporates but for governments.”
Source: Reuters

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