Whereas most major events are unpredictable by their very nature, the pattern of equity markets’ reaction is even more so, Sandro Occhilupo from Decalia Asset Management writes in his exclusive essay for finews.first.
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Considering today’s larger-than-life authoritarian rulers such as Trump, Putin, Xi or Jong-un, with their ego-driven power struggles, ever-changing web of alliances, and unpredictable plot twists, one would have good reason to believe that the world has turned into a «Game of Thrones» fantasy drama.
This, in turn, has raised again the «specter» of geopolitical risk over global financial markets with investors getting increasingly nervous about escalating crises and potential trade wars. Admittedly, Daenerys’ quote «turn us away, and we will burn you first» may appear somewhat far-fetched in today’s context but one must admit that, given the aforementioned cast of characters, the risk of seeing a minor conflict rapidly growing out of proportion cannot be excluded.
«Geopolitical events often provide good entry points for long-term investors»
That said, recent history tells us that most threatening conflicts end up being war of words only, with rhetorical escalation seldom followed by meaningful action as proud protagonists’ generally back down with honor after seeking negotiated «win-win» solutions with each side.
The key point here is that, while causing both greater nervousness and higher market volatility, such geopolitical events often provide good entry points for long-term investors. Indeed, as a matter of fact, several reports (e.g. 2016 Credit Suisse study on major geopolitical events in the past 100+ years and a 2017 Charles Schwab survey carried over 37 similar developments since 1980) have demonstrated that such occurrences eventually created more short-term noise than sustained impact on markets.
In fact, not only have stocks not always declined in response to such incidents, but when they have, drawdowns have on average been limited to three percent, with a duration of just seven days.
«We note equity markets’ strong performance during Ronald Reagan’s protectionist era»
Therefore, it was no real surprise to see Trump’s recent military response in Syria not bothering the markets much. Moreover, latest concerns about a potential trade war with China rapidly eased after investors realized negotiations would likely follow earlier hostile announcements.
Even major events such as the assassination or Archduke Ferdinand (1914), Cuban missile crisis (1962), the invasion of Iraq (2003), and the 9/11 terrorist attacks saw initial equity markets pullbacks of around ten percent being reversed within a month or so. On the longer run, interestingly, we also note equity markets’ strong performance during Ronald Reagan’s protectionist era in the 1980’s.
«I do not believe that winter is coming yet for equity investors»
In other words, whereas most of these events are unpredictable by nature, the pattern of equity markets’ reaction is often more so, all else equal. This observation combined with the current robust global economic and earnings growth environment thus keeps us constructive on risky assets ahead of further potential geopolitical turmoil (e.g. Nafta).
Indeed, such risks are, and have always been, an inherent and unavoidable element of investing. For long-term equity investors in particular, panic selling on negative geopolitical headlines rarely proves to be a smart move.
Quite the contrary in fact as initial indiscriminate market pullbacks often provide a unique opportunity to cherry pick high-quality stocks at more attractive levels. As a result, unlike in «Game of Thrones», I do not believe that «winter is coming» yet for equity investors and thus recommend to stay patient and selective when on the lookout for bargains.
Sandro Occhilupo is the Head of Discretionary Portfolio Management and Senior Fund Manager at Decalia Asset Management in Geneva.
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