Are markets underestimating geopolitical risk?

Geopolitics

Every week it appears that North Korea tests a missile that falls safely in the Sea of Japan. Saudi Arabia and its close neighbour Qatar are having a spat about terrorism funding, could they come to blows and what would that mean for the oil price? Should we worry about such events? And how will it affect our savings and investments?

Such heightened risk events are perhaps more frequent than we think, and yet stock markets have often climbed in the face of such events.

Going back to the 1990s and the disintegration of Yugoslavia is an example of such stock market climbs. Various wars took place on the doorstep of Europe between 1991 and 2001, and Yugoslavia was a country where many used to take their annual holidays. After the death of Tito the various separate regions split and established their own countries, and yet from a stock market perspective, the 1990s were a period of bull market returns culminating in the dot.com boom. So we can assume that stock markets never saw this particular crisis as a major risk.

Severe geopolitical events… are hard to predict

More recently the Iraq war started in March 2003 also saw a period stock market rises. In 2004 the FTSE All Share actually rose by approximately a third. During the period between 2000 and 2009, the stock markets reeled more from the fall out of the tech bubble and the Great Financial Crisis than any conflict.

Severe geopolitical events, and in particular their fall-out, are hard to predict and take the time to unravel. If they lead to a collapse or disruption to world trade then that will feed through to corporate profits, and thus the expectation that stock markets will suffer.

Both of the events described above did not appear to hinder economic growth. However, the global financial crisis may have had even more serious consequences than it did for stock markets if liquidity had completely dried up without the intervention of central banks and quantitative easing.

Keep aware of possible geopolitical events by all means, just realise the outcomes are very hard to predict.

 


The above article was first published by Parmenion on 11th July 2017

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