Author: Dr Shane Oliver, Head of Investment Strategy and Chief Economist, published on 14 March 2018.
In this week’s Oliver’s Insights, Dr Shane Oliver looks at why geopolitical issues are more important for investors these days and what to look out for this year.
The key points are as follows:
- Geopolitical issues generate much interest as dinner party conversations but don’t necessarily have a significant impact on markets, apart from a bit of noise.
- But given a backlash against economic rationalist policies, the declining relative power of the US and the ability of social media to allow us to make our own reality, geopolitical risks are higher than they used to be.
- Key issues to watch this year are: around President Trump given the mid-term elections, particularly on tariffs (notably in relation to China) and the Mueller inquiry; the Eurozone after the messy Italian election and the likelihood that Merkel and Macron will work to build a stronger Europe; North Korea; and China.
- Given the difficulties in trying to predict geopolitical shocks and their impact it often makes more sense for investors to focus on the investment opportunities, they throw up, rather than taking long-term shelter from them in low returning cash.
Geopolitical events like Brexit and Donald Trump’s election in the US “surprised” investors in 2016 but had no lasting negative impact on global financial markets.
By last year investors were well focussed on geopolitical risks – Trump taking over as US President, Eurozone elections, the Communist Party Congress in China and rising risks around North Korea – but again they did not have a much lasting negative market impact. In fact, in most cases, it turned out to have a positive effect.
Now in 2018, it’s already clear that geopolitical events remain significant, for example with Trump’s tariffs and the messy Italian election result. Despite their benign financial market impact over the last two years, they are worth keeping an eye on.
Why geopolitics is more important now
While not to deny the influence of various geopolitical events in the 1980s and 1990s the broad trend was reasonably positive with the embrace of free market/economic rationalist solutions (after the failure of widespread government intervention in the 1970s), the collapse of communism and the associated surge in global trade and the peace dividend and the dominance of the US as the global cop.
However, while the last 2 years highlight the importance of not getting too distracted by geopolitical events, in recent times geopolitical risks have arguably become more elevated. There are several reasons for this:
First, the slow post-global financial crisis recovery, rising inequality (see the next chart which shows the Gini coefficient – a measure of income distribution) and stress around immigration have all led to a backlash against establishment politics and economic rationalist policies.
This is showing up in support for re-regulation, nationalisation, increased taxes and protectionism and other populist responses, which could slow growth and share markets. While aspirational politics ruled in the 1980s & 1990s it’s since been replaced with scepticism about trickle-down economics.
The swing of the political pendulum to the left is most acute in Anglo Saxon countries as it was here that the pendulum swung most towards free markets in the 1980s and 1990s.
It’s messy in the US as while Trump has tapped into popular discontent and is more protectionist, his policies around de-regulation and tax cuts go in the opposite direction – for now, as this could just set the scene for a more left-wing president in 2020.
And Macron in France is going in a fundamentally more pro-business direction, which is very positive for French assets.
Second, the relative decline of US economic and military power is shifting us away from the unipolar world that dominated after the Cold War when the US was the global cop and most countries were moving to become free market democracies.
Now we are seeing the rise of China, Russia revisiting its Soviet past and efforts by other countries to fill the gap left by the US in parts of the world, all creating tensions.
Third, social media is allowing us to make our own reality. The danger is that, as politicians pander to this, economic policymaking will be less rational and more populist.
Finally, with the mid-term elections in November, Trump is back in campaign mode. And he is not your normal politician.