On the morning after the missile strikes were exchanged between Iran and Israel, global markets flinched, oil prices skyrocketed; while the gold held its position as the safe asset choice, however, the equity market lost its shine beneath the smoke of war and uncertainty.
Our portfolio managers at Nexent Capital, weren’t just reading the news, they were strategizing. They were assessing the clients’ portfolios, running the sensitivity parameters to evaluate the impact of the geopolitical events on the portfolios. In today’s interconnected world, with the U.S. playing an increasingly prominent role in most of the events, geopolitics has become one of the most significant concerns to drive financial markets and often in a wrong direction.
Now the question arises: what exactly are geopolitical risks and how do they impact the financial markets?
There is no single cause behind geopolitical unrest – it can spark from many issues including but not limited to war, terrorism, and political tensions involving world economies and societies. Each of these factors has the potential to disrupt global markets in unpredictable ways.
And sometimes these events don’t even have to be global to have a disastrous impact on the financial markets. Local conflicts can carry just as much weight as global turmoil. When these issues unfold, they potentially disrupt financial markets in unpredictable ways.
The effect of these events ripples through economies, and at that point these issues no longer remain political, they become a nightmare for financial markets.
What happens when crisis hits?
Energy Resources:
The first resource to get impacted from a geopolitical concern is often oil! Take the example of Russia-Ukraine conflict. While the tension between the two countries have been long standing for years, it was February of 2022 when Russia launched a full-scale invasion on Ukraine. Being one of the largest oil producers, Russia’s attack on Ukraine drastically impacted the global energy market. Oil prices jumped by over 20%, contributing directly to the early onset of global inflation.Valuable Metals (Gold):
Unlike energy, gold remains an investor’s friend in times of geopolitical unrest and that’s why it is widely considered a safe-haven asset. Even during economic volatility, gold is expected to retain or even increase in value, as safe-haven assets are often inversely correlated with stock markets. For instance, the recent escalation in the Middle East caused an all-time spike in the gold price at $3,387.99 per ounce. But despite gold’s lustrous safe-haven appeal, the immediate resort to buying gold during every crisis may not always be a wise strategy, as these behaviors are often volatile. Further, gold prices go back to pre-crisis levels after an initial spike. Therefore, it is always recommended to look at the underlying fundamentals and investors should not make gold-buying decisions based solely on geopolitical headlines.Bond Market:
At the time of geopolitical turmoil, having a government bond on the portfolios can slightly ease off the shocks from geopolitical risks. Because, governments can often anticipate geopolitical risk, investing in government bonds, particularly in U.S. Treasuries, can reduce the negative impact of global tensions. This is why government bonds are frequently seen as a safe haven for investors seeking stability. For example, during the recent Middle East conflict, there was a notable shift of funds from equity markets to U.S. Treasuries. This term is often referred to as “Flight to Safety” or “Flight to Quality” where investors move their capital away from riskier assets like emerging market investments, into a safer option. Investors can also consider investing in corporate bonds, which typically offer higher potential returns but come with greater credit risk. Government bonds, on the other hand, offer safety and predictability, making them a popular choice during geopolitical crises.Stock Market:
During times of geopolitical crisis, the stock markets can quickly turn into what feels like a shock market! Unlike gold, which tends to rise during uncertainty, the nexus between geopolitical events and its impact on the stock markets is often not as friendly. While these events usually do not leave any lasting impact on large cap equity, they can gravely impact the local market. For example, the recent U.S. presidential election brought significant market volatility due to uncertainties of the new government policies. Initially, investors witnessed a boost in the financial market but after the announcement of new tariffs, the S&P 500 dropped by nearly 15%. This dip somewhat recovered after President Trump paused the tariff plans, but that recovery was soon shaken again as tensions in the Middle East escalated. This highlights how financial markets respond at the time of any domestic and international conflict. These are just a few examples to show that no two class assets respond in the same way to geopolitical conflicts. While safe haven assets like gold and government bonds may experience minimal impact, other assets like oil and equity markets may fluctuate dramatically. It’s essential for investors and strategists to not react in haste but to understand these behaviors so as to build a strong portfolio which can withstand uncertain times. The only thing that is certain at the time of a geopolitical crisis is UNCERTAINITY of financial markets! But theory can only take us so far! To fully understand how different asset classes respond during these crucial times, we reached out to one of our leading portfolio managers for practical insights. We wanted to dive deeper and asked the strategist how to navigate geopolitical risks in real time.Here is what they have to say:
1. How would you define geopolitical risk from a portfolio management perspective?
Strategist: Geopolitical risks are international political events involving two or more countries which cause financial uncertainty and tensions. These include events such as wars, sanctions, trade wars and supply chain disruptions. These are some of the examples which impact the investor’s confidence and investment assumptions. Such events can disrupt stock markets, trigger inflation, cause fluctuations in currency exchange rates, interrupt government fiscal budgets and challenge economic growth assumptions. Ultimately geopolitical risks have the potential to influence the asset returns, market volatility, commodity prices, interest rates, all of which directly affect how we manage our clients’ investment portfolios.
2. What geopolitical risks are you watching right now?
Strategist: In today’s times where things are constantly changing at the snap of fingers, I’ve quite a few geopolitical risks on radar. These include – President Trump’s global tariff imposition, ongoing conflicts in the Middle East, the U.S.-China Trade wars, the Russia-Ukraine standoff and of course the India-Pakistan conflict. Each of these situations has the potential to disrupt the financial markets. And not just that, we live in a world where economies are so interconnected these conflicts can give rise to other unforeseen risks. As a portfolio manager, it is crucial to keep a close tab of these events and assess how they could influence future uncertainties.
3. When a new global conflict breaks out what are your immediate reactions as a financial strategist?
Strategist: My immediate response is to assess how our portfolios are involved with the affected regions and sectors involved; I determine this in order to adjust hedging strategies. I also focus on diversifying the portfolios further to reduce the impact from any geopolitical issue and move towards less volatile asset classes.
4. What’s the most common reaction of clients at the time of geopolitical issue breakout? How do you reassure or strategize for them?
Strategist: Clients often panic when a geopolitical crisis breaks out. They feel compelled to exit their portfolio by selling the assets in ways that sometimes contribute to sharp sell-offs. In these moments, reassurance is crucial, and I usually encourage clients by suggesting longer holding periods, informing them the historical patterns where such opportunities are considered as “buy-the-dip” opportunities, explaining the strategies adopted by the fund based on the new situation. I also assure the clients that their portfolios are being managed by keeping the situation in mind.
Geopolitical events are unpredictable and will keep making headlines that ripple through the financial markets. As we know by now that uncertainty is certain – so is the value of well-built financial portfolios.
If you’d like to learn more about geopolitical risks and its impact on financial strategy, feel free to reach out to us at Nexent Capital.
