If you think what happens abroad stays abroad, think again. Global borders are disappearing — at least financially speaking. As far as the stock market is concerned, we’re one interconnected, global family, and we largely rise and fall together.
When our British cousins decided to break with the European Union, American markets plummeted for two days. Earlier this year, the Standard & Poor’s 500 index fell 10.2 percent as investors fretted over the possibility that inflation and interest rates were rising. These fears were bolstered by the threat of the U.S. imposing widespread tariffs on imported goods to promote “fair trade,” says James Ragan, a director of research at D.A. Davidson in Seattle.
“Geopolitics adds uncertainty to the investor equation, and uncertainty usually results in increased volatility in the form of market declines and sometimes market rallies,” he says. Just look at the global financial crisis of 2008 and 2009, when a subprime mortgage crisis in the U.S. led to a full-fledged international banking crisis around the world.
“Geopolitical risks have made their way to the top of the list of disruptors that could bring an untimely end to the good times,” says Bodhi Ganguli, lead economist at Dun & Bradstreet in Short Hills, New Jersey. Political and economic changes accounted for more than half of Dun & Bradstreet’s country risk-rating changes between 2012 and 2017, according to the firm’s economists.
“Geopolitical instability is highly correlated with global market volatility and has a history of creating both risk and opportunity for investors,” says Martin Jarzebowski, vice president and portfolio manager for Pittsburgh-based Federated Investors.
He says the intersection of geopolitics and investing is best described by a quote from “The Godfather Part III”: “Finance is a gun; politics is knowing when to pull the trigger.” But investors also need to know where to aim the gun, and that requires understanding which geopolitical hot spots pose the greatest risks and opportunities.
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Sanctions against Iran bode well for the energy sector. President Trump’s decision to withdraw from the Iran nuclear deal is a perfect example of “how a political decision by one government can have a far-reaching impact on global geopolitics and investments,” Ganguli says.
The re-imposition of U.S. sanctions will put added strain on Iran’s economy by preventing international banks from financing trade deals and investments, he says. Dun & Bradstreet is in the process of downgrading Iran’s country risk three notches from DB5a to DB5d.
Sanctions will also inhibit Iran’s exports, most notably oil. “Since Iran is a major oil producer, this would lower global supply, leading to higher oil prices and possibly stimulate more U.S. production,” Ragan says, a benefit for the energy sector.
Russian investments become an even riskier bet. “Russia, likely to emerge [as] one of the key players in the Iran situation after the dust settles, is another geopolitical hot spot,” Ganguli says. A nerve gas attack in the U.K. against a former Russian spy and his daughter led to the expulsion of Russian diplomats from more than 20 countries, including 60 Russian officials from the U.S. alone.
U.S.-Russian relations, already in a compromised position after the 2016 U.S. elections, continue to deteriorate. The U.S. imposed sanctions on Russian businesses and oligarchs close to Putin, including Rusal, the world’s second-largest aluminum company. These sanctions have affected global finance and commodity prices, Ganguli says, particularly for aluminum.
Aluminum prices spiked to their highest point since 2011 before tumbling downward as Washington extended the deadline for American companies to comply with the sanctions. As a result, Russian investments are likely to see increased volatility and risk premiums in the coming months, Ganguli says.
Unsuccessful North Korean talks could prompt a sell-off. Friend, foe or something in between, North Korea remains a major source of geopolitical uncertainty and risk. “In recent weeks the world has gone from fearing a military conflict between the U.S. and North Korea to witnessing a peace accord handshake between the leaders of South Korea and North Korea,” Ragan says.
Add to this North Korea’s pledge to denuclearize the Korean Peninsula, and no one knows quite what to expect next. “This creates some risk if ongoing negotiations break down or revert to a more hostile tone,” resulting in a decline in the S&P 500, Ragan says.
“However, a potential sell-off would extend only if company earnings are negatively affected,” he says. This could easily occur if hostilities resume as military conflict can cause consumer spending to decline. Investors should closely monitor U.S. consumer spending data to predict how the market might move.
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U.S.-China tariffs could benefit South America and the Middle East.The possibility of a trade war between the U.S. and China threatens markets through potentially higher interest rates, Ragan says. Tariffs raise the cost of goods for companies, a cost they then pass onto consumers through higher prices. Higher prices mean inflation, and inflation leads to rising interest rates, which ultimately lowers earnings and hurts stock market performance.
“The current stage of a tit-for-tat tariff game [between the U.S. and China] presents headline risk for markets, but the real fear would be an escalation into a trade war with global ramifications,” Jarzebowski says. “No one wins a trade war,” but some regions may temporarily benefit from strained U.S.-Chinese relations.
South America, for instance, produces many of the same agricultural products as China. Similarly, the Middle East could benefit from Chinese tariffs on U.S. fossil fuels.
However, “an escalation in any form of conflict between the two largest economies in the world, geopolitical or trade, will be detrimental to global growth,” Ganguli says.
U.S. midterm elections could hurt energy, financials and health care. Sometimes the greatest geopolitical threat is at home. “The most significant geopolitical event on the calendar is the U.S. midterm elections for the House and Senate on Nov. 6,” Jarzebowski says.
“If one of the chambers shifts to a Democratic majority, then we can expect increased policy gridlock on Capitol Hill,” he says. If both chambers shift, investors could see more market volatility.
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The “sectors with the most at stake include energy, financials and health care,” he says. Each of these sectors benefits from the current administration’s deregulation policies. A change in these policies — which is more likely to occur with a Democratic House and Senate — could hurt these sectors.
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5 Geopolitical Hot Spots That Could Sway Markets originally appeared on usnews.com
