Print
In the most recent Bank of America Global Fund Manager Survey (October 2024), managers were asked what they considered the biggest “tail risk.” Their answer: geopolitical conflict. So, if you’ve been thinking about geopolitical risks and their potential effect on portfolios, you are certainly not alone.
With that in mind, let’s look at recent geopolitical events, how they might affect investments, and why news around these risks may have an immense effect on investor sentiment but not necessarily on their portfolios.
Geopolitical Tricks
The sad reality is that conflict is almost always happening around the world. For thousands of years, people have been fighting over territory, resources, and more. And it’s not entirely wrong to feel like conflict has increased over the past year. The Armed Conflict Location & Events Data (ACLED) team has found that an estimated 1 in 7 people have been exposed to conflict so far in 2024; 50 countries rank as having extreme, high, or turbulent levels of conflict; and political violence incidents have increased 15 percent in the past month (as of July 2024 update).
Indeed, geopolitical conflicts including next week’s election, the Russia-Ukraine war, and fighting in the Middle East are top of mind for many. Feelings of uncertainty and the images associated with these events may naturally create a flight-to-safety reaction for investors. But a flight to safety could come at the cost of potential future returns. Investors should think not only of the risk of a loss of capital but also of the opportunity risk that moving assets into historically lower-risk assets might mean for their time and ability to achieve their goals and objectives.
This idea was highlighted by my colleague Chris Fasciano, who showed in his recent post that returns two years post-election for the S&P 500 averaged 8 percent from 1940 to 2022. We have also seen positive S&P 500 returns from both the start of the Russia-Ukraine war and the resurgence of conflict in the Middle East.
Returns Do Not Reflect Specific Underlying Risks
This is not to say we should brush off current conflicts and follow the historical data. Although this approach may save time in our analysis, as we always see in the disclosures: past returns are not indicative of future results. For this reason, it makes sense to try to understand how these conflicts might impact our investments.
The rising debt and deficit level is one of the many risks emerging from current geopolitical events. Investors are concerned about this rising deficit, as the U.S. provides financial support for allies while building out its own military. While I leave it up to my colleagues on the fixed income team to delve into the finer details such as issuance, foreign buyer appetite, and relative global yields, we have seen that military spending is usually a large portion of government spending. France was recently downgraded by Moody’s as the country looks to reduce its deficit from 6.1 percent of GDP to 5 percent of GDP. Downgrades in debt can lead to higher borrowing costs and higher interest rates as government yields must move higher to compensate investors for higher risk levels.
For equities, we try to focus on how geopolitical events may impact companies’ abilities to carry out their business. The Russia-Ukraine war has included multiple major events that have affected companies. As Russia was an energy provider to Europe, the U.S., Norway, and Northern Africa had to pick up the slack as suppliers. We’ve also seen rising sanctions and restrictions on semiconductor exports to Russia and China, the delisting of Russian companies from U.S. exchanges, and the removal of Russia from the SWIFT banking network. These moves directly affected U.S. and European companies within the energy, financials, and technology sectors. They also led to questions over how companies may be affected in the future and how Russia, China, and other BRICS nations may conduct commerce and manage their currency reserves going forward.
There is a wide swath of potential risks from outcomes in these conflicts, but we tend to focus on what the company does; what these changes mean for the company’s ability to generate revenue; and the impact on its margins, earnings, and potential future cost of capital, among other finer details. Thinking these details through can also help investors determine where to source their allocation if they wish to adjust their exposure around any conflict based on their values or objectives.
Geopolitical Treats
Despite the uncertainty surrounding these geopolitical conflicts, they can create investment opportunities. The U.S. is exceptionally fortunate for several reasons, including its geography (with two oceans on either side), its military, and its public markets. U.S. markets allow individuals to invest in publicly traded companies with different exposures, technologies, products, services, and values. Additionally, the collection of these companies through diverse investments like those of the S&P 500 benchmark have shown the ability to bounce back over time (see chart below).
Source: MFS
In closing, as you think about making portfolio adjustments based on geopolitical events you may see in the news or the world around you, it may help to keep these “geopolitical tricks and treats” in mind.
