In the past few weeks, the VIX index – a “fear” proxy – leapt amidst escalating sabre-rattling between the US and North Korea.
It has now come back down to subdued levels with Donald Trump praising Kim Jong Un for his “very wise and well-reasoned decision”. But given the instability in the US chain of command at present, this may well burst onto into the forefront of consciousness again at any moment.
What impact do they have on risk assets? Should investors adjust their portfolios when red alerts hit their screens? The short answer: no. Financial history shows geopolitics rarely impact equity markets over the medium to long term.
Indeed, geopolitical crises, for all their horrific images, real-time press coverage and social angst, simply do not appear to affect markets often. For example, the world was brought to within an inch of nuclear Armageddon during the Cuban missile crisis in October 1962 (markets were reasonably flat in the months leading up to the crisis). An investor in the S&P 500 – a US and global equity bellwether – would have been up 7 per cent in the following month, up 16 per cent over the next quarter and up 34 per cent a year later. Khrushchev may have blinked, but investors were on a roll.
Though investors at the time were indeed relieved that the world did not end, it hardly meant an end to tensions. The Cold War was still very much in full swing, and less than two years later, in August 1964, the US Congress passed the Gulf of Tonkin resolution officially “authorising” the Vietnam War. With the US waging a tremendously costly war across the globe, one would imagine equities performed poorly. Once again, investors were rewarded by staying the course: the S&P 500 returned nearly 9 per cent over the following year.
The experiences above are not isolated. Investing in the S&P at the advent of the Six-Day War in 1967 between Israel and its neighbours would have returned 13 per cent over the next year. Investing when the Soviets invaded Afghanistan in December 1979 would have returned nearly 10 per cent in the next six months, a return that shot up to 30 per cent in the next 12 months. More recently, the invasion of Iraq during the first Gulf War in March 2003 delivered strong returns for investors: the S&P rocketed up by 35 per cent in 12 months.
Analysing 16 serious geopolitical crises since 1950, only four saw the S&P down one month later. Similarly, four events saw markets lower over the next six months or the next 12 months. Of the 25 per cent of times where the market did turn down, the factors were often not entirely geopolitical, if at all. During the Arab-Israeli War of 1973, the oil embargo was indeed a main cause of inflation.
However, the Bretton Woods system – an international monetary order that fixed exchange rates that had been in place since 1944 – had only recently collapsed. Additionally, following September 11, equity markets lost value, but arguably the boom and bust of the nascent tech sector was a core driver of those losses.
Geopolitical tensions are likely to continue dominating the headlines in the coming months; upcoming elections in Germany and Italy are just two of a number of imbroglios. While they will undoubtedly cause jitters in the short run, their impact on medium and longer term performance is likely to be minimal.
Instead, medium and long term investment performance is driven by fundamentals rather than geopolitical headlines. Market fundamentals such as equity valuations which are increasingly expensive, but not alarming, and continued strong positive momentum, point towards further gains in equities, thereby supporting our “risk on” stance. We will change our view when the conditions warrant a change: if momentum were to turn negative, if valuations become overly extended, and/or sentiment became overly bullish. For now, none of these conditions are on red alert, though some admittedly are flashing amber.
Following the acquisition of Kleinwort Benson by Societe Generale in summer last year, SGPB Hambros and Kleinwort Benson will be legally merged in 2017 under the name Kleinwort
Hambros. Led by Chris Perkins, Kleinwort Hambros, which is based on the Harewood Estate between Leeds and Harrogate, provides wealth management, fiduciary, investment and
financial services planning services for its clients. It believes that Yorkshire will play a central role in the success of the Northern Powerhouse.