Précis of Oliver’s Insights 20 June 2017 by Dr Shane Oliver, Head of Investment Strategy and Economics and Chief Economist at AMP Capital. See the full article.
A year ago Britain voted to leave the European Union. Since then, we’ve also seen a messy election result in Australia, Donald Trump's surprise victory in the US presidential election, increasing concern around North Korea and a steady flow of terrorist attacks.
The combination of these seemed to highlight the importance of geopolitics for investors. Yet the impact on markets has been benign. Since the Brexit vote, global shares are up around 20% and Australian shares are up around 13%.
A look back: Why the markets have stayed buoyant
There are several reasons why geopolitical events have had little impact on investment over the last year or so:
- Europeans have refused to play along. So far, there’s been no evidence of Brexit triggering a domino effect of countries also seeking to exit the European Union (EU). In fact, post-Brexit elections in Spain, Austria, the Netherlands and France have all supported centrist pro-Europe parties.
- Trump’s practical policies - not populist ones - are dominating. Trump has appeared more focussed on pro-business policies such as deregulation and tax reform, than his more populist policies.
- Global growth has improved. This and rising profits has swamped geopolitical worries.
- Uncertainty over geopolitics has led to growth-focussed monetary policies. Particularly in US and Europe, there’s been a focus on continuing to boost economic activity by keeping interest rates low.
- In Australia, the Government was returned so there’s nothing new, which is not great, but not a disaster.
What's happening now: current geopolitical risks
The last 12 months is a good demonstration of why we shouldn’t get too excited about geopolitical events, but it’s still important for investors to keep an eye on them. Current areas of increasing geopolitical tension include:
1. A backlash against economic rationalist policies (deregulation, privatisation, and globalisation). Rising inequality in some countries and stress around immigration is driving populist responses like re-regulation, nationalisation, increased taxes and protectionism which could slow growth and share markets.
Politics in the UK has swung to the left. In the US, it’s doubtful Trump’s policies (eg cutting healthcare) will deal with rising inequality, setting the scene for a more left-wing candidate to win the 2020 election. In Europe, while it’s always been more left-wing anyway, France appears to be heading in a more rationalist direction.
The future: global geopolitical issues to keep an eye on
The geopolitical issues worth watching are:
- The German election (September 24) – Chancellor Angela Merkel looks on track to win but if she doesn’t, the Social Democrat Party under Martin Schulz will. And either way, the German support for Eurozone integration is likely to be stepped up.
- The Italian election (due by May 2018, but possibly this year) – support for the EU is weaker in Italy and could cause a new round of break-up fears once its election date is fixed. But even if a Eurosceptic party does win, it’s not likely to get a majority or form a coalition government.
- Greece seems to be creeping towards debt forgiveness, but this may have to wait until after the German election. And there’s no longer a populist Eurosceptic party for the Greeks to turn to. More broadly - at some point investment markets are likely to tire of fearing a Euro exit at every election. It’s been going on since 2010 and the overall trend is pro EU.
- The US presidential impeachment risk – the main risk for investors here is that the noise around the Trump/FBI/Russia issue distracts the political process to such a degree that Trump’s pro-business agenda stalls.
- The US shutdown/debt ceiling risk – in September, funding will have to be renewed for the US Government to avoid a shutdown and by early October the debt ceiling will need to be raised again. Both are likely to happen – as 2013 showed, no side wants to be blamed for a shutdown or debt default.
- The impact of terrorism –investment market impacts have been declining since the 9/11 attacks. While horrible from a human perspective, most don’t really have much economic impact and, after a while, economies and markets become desensitised to them to a degree.
- Iran v Saudi Arabia – tensions are likely to remain but are very unlikely to break out into warfare between the two.
- North Korea – missile tests have increased and soon they may have the capability to lob a nuclear missile into the US (or Australia). A US missile strike is possible but a diplomatic solution is most likely, and trying to protect an investment portfolio against the uncertain timing of North Korean risk is a bit like trying to protect it against a nuclear war in the Cold War.
- China/US relations – so far so good. Trump’s working through trade issues with China and cool heads are prevailing regarding the South China Sea. How the renegotiation of the North American Free Trade Agreement goes will provide some insight into how Trump’s proceeding on trade. But so far it’s been more rational than feared.
Overall implications for investors
Based on the experience of the last year around geopolitical risks, there are several implications for investors:
- Turn down the noise. Geopolitical issues create much interest but this doesn’t mean they’ll have a huge negative impact on investment markets.
- It’s hard to quantitatively build geopolitical risks into an investment process. You really have to understand each issue separately.
- The ultra-short-term impact of the Brexit and Trump election shocks – with both seeing an initial fall in share markets followed by market strength – highlights the benefit in looking for the opportunities geopolitical shocks throw up.