What are the real political risks clients need to know about?

By Christopher Smart

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Aug 16, 2018
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As we enter year nine of the “great recovery”, there is talk about good economic numbers amid rising levels of political risk.

But just how is the world so much riskier now than in periods around, say, the Cuban Missile Crisis or the remilitarisation of the Rhineland? Not all political risks are alike, nor do they all have the same impact on investment strategies.

Political risk for investors fall into three baskets:

  1. the noise, which you should ignore;
  2. the shocks, which are likely temporary; and
  3. the tectonic shifts, which could threaten to bring the whole system down.

Arguably, the risks that make us all the most nervous come from the unsettling headlines of our daily news feeds: vans driving into pedestrians, cyber breaches and angry politicians promising to overturn the current order. While troubling, it is hard to price any of this noise into a discounted cash flow.

The potential shocks are even harder to factor into an investment strategy. The historical record offers some grounds for comfort. Sometimes there are rate cuts or fresh government spending to cushion the blows. Sometimes the shock subsides, and investors realise their portfolios don’t look so bad after all. For example, stock markets recovered all losses within a month after 11 September and within two days of President Kennedy’s assassination.

Current powder kegs range from uncertainty in Latin America to rising tensions with Iran, to the still unresolved tensions in Korea. Odds are, these will all be on our list of worries for years to come. If one of them does blow, however, there would more than likely be emergency monetary and fiscal measures to cushion any spike in oil prices or bond yields. There would be diplomatic interventions to keep things from spiralling out of control. The brutal fact is that a regional humanitarian disaster is less likely to trigger a systemic market crisis.

Are we headed for a clash of civilisations?

The real political risks to the global economy are far more insidious and less easy to track, found in the slow and unmistakable realignments of global power. China is growing more assertive as Americans themselves question the costs of global leadership. The current administration’s “America First” rhetoric and iconoclastic style have led friends and foes alike to re-examine their assumptions about the post-war order: Is the US pulling back? Will the world fall into rival regional camps? Are we headed for a clash of civilisations?

This is important for investors, because they need to assess the resilience of the global system when the next crisis comes. We don’t know when that next crisis will come or what it will look like, but we do know we will need a massive and coordinated response to limit the damage.

Next time, as they say, will be different

When the G20 convenes for the next crisis, its members will all want to avoid a collapse, but many will also be looking to throw an elbow among increasingly toxic relations with rivals. China might convince itself that it can withstand market turmoil better than the US and focus on the stability of its regional partners. The US might try to use the market pressures to extract trade concessions from Beijing. Europe is already asking serious questions about the future of trans-Atlantic relations.

Failure and collapse are by no means inevitable, but cooperative crisis management is much less likely today than it was 10 years ago. If you are an investor with a time horizon that extends more than a few months, keep your eyes focused on the uncertain chances of success.

Christopher Smart is head of macroeconomic and geopolitical research at Barings

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