June 28, 2018
To much has been made from terms like “political-risk trade,” “geopolitical risk premium,” and geopolitical tensions and headwinds that are supposedly driving global markets. These terms are causing everything from defensive tones in markets, bond sell-offs, trade war uneasiness and debt sustainability fears. Add anxieties and concerns over Italian governance structure, Turkey under Erdoganbecoming a dictatorship similar to President Xi’s power grabin China, major US sanctions on Russia,Venezuela’s collapse, the Iran nuclear deal in “critical condition,” and populist leftismtaking hold in Mexico’s upcoming elections; and what investors should have is volatility in currency, bond and stock markets. However, the CBOE Volatility Index (VIX) remains subdued, but the same geopolitical sentiments were bandied about in 2017 that markets were crashing over world events. Yet when examined factually – 2017 was a banner year for investors – and economies.
The prior year’s investment portfolio deliveredincredible results for investors: US stocks produced 20% returns with roughly 8.5% volatility, historically high Sharpe ratioratio of 2.4 (7-times the long-run average for the S&P 500), sustained global growth, lower inflation, good credit-spreads, a weaker dollar and rebounding oil prices from the 2014 crash. US Treasury’s stayed around 2.4% despite three US Federal Reserve interest rate hikes and corporate tax reform that is paying off with $300 billion repatriated back to the United States in the first quarter of 2018 accordingto the US Bureau of Economic Analysis.
Even the Economic Policy Uncertainty Index(EPUI) was calm for 2017:
“Marked by the absence of controversial elections, abundant liquidity, good growth, falling unemployment, few major military clashes and a US President focused on domestic matters contributed to an all-time low VIX reading in September 2017.”
In other words we have the same conditions in 2018 that occurred in 2017. Additionally, a majority of Americans, which will help calm geopolitical tensions and help markets and investors, believewe have the diminished threat of nuclear war with North Korea after the Trump-Kim summit. The biggest investment concern for 2018 should be how Shanghai’s benchmark stock index, “plunged to its lowest level in two years,” off US trade war concerns that have created a “bad sentiment for the market as a whole.” But the upside for Chinese investors domestically and globally is great news from a recent International Energy Agency (IEA) reportthat stated:
“China, whose market grew by an astonishing 15% in 2017 with a strong coal-to-gas switching program in the residential and industrial sectors, is set to continue to lead the trend with an expected average annual growth rate of 8% for the next five years. Driven by continuous economic growth and strong policy support to curb air pollution, China accounts for 37% of the global increase in gas consumption between 2017 and 2023, more than any other country.”
These are solid economic reasons to invest in the natural gas portion of the energy sector through all facets of the industry. Pipelines, steel, trucking, drilling services, etc., instead of being concerned about geopolitics that are hard to define and constantly evolving without giving concrete investment directions. Search for US, European and Asian firms that have a leading role in the supply and export growth of liquid natural gas (LNG). As shale output is expected to support the US exceeding 11 million barrels per day(bpd), and this means tight oil output will lead to increased fracking for natural gas. China has demand for LNG and the US can supply their needs; outside of politically heated buildup to trade wars that likely won’t take place or will be muted in their size at best.
Furthermore, in this environment that is saturated with geopolitical news, look for active private equity firms, global growth managers and hedge funds that focus on industries with multinational leadings firms that can navigate political stress. Exploiting global growth in 2018 will still be determined by supply and demand, clean financial statements; cash flow and are you an industry leader in your sector.
The situations in Iran, Venezuela, Libya and China’s hegemonic behavior in the South China Sea are distressing, but market impacts should be limited. At least Libya’s attemptingto fix their internal energy issues and China wants economic growth more than a war with the US or other Asian nations over the South China Sea or Taiwan, but Venezuelaand Iranshould be closely watched over large supplies of crude oil disappearing from the markets over geopolitics.
Venezuela and Iran are current, ongoing examples where geopolitics is shaping supply and demand and that should be closely monitored. But investors can use this geopolitical stress to their advantage and go long on oil futures, particularly with hot summer months leading to the US and other western nations demanding more oil and petroleum products.
If geopolitics sways your investment decisions then watch if the US dollar continues strengthening will it cause emerging-market currency weakness? Moreover, will interests rates keep rising over better economic indicators and if US high yield credit spreads to determineif there, “is a liquidity or solvency squeeze.”
Geopolitical events can certainly weigh on the market but there doesn’t seem to be any risk – outside of global energy prices rising – for other sectors to morph into crisis. Going back to the EPUI – it is still one of the best ways to track – anxious investment sentiments over world events and erratic political behavior. The latest readings indicate markets aren’t convinced there is a cataclysmic incident or contagion at this time or on the horizon. Let wise, economic reality and bullish attitudes guide your investments for the second half of 2018.