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Political scenarios and their impact on markets, investor psyche
THROUGHOUT 2017, the world was rather stable. Global GDP saw healthy growth, there was the prospect of tax measures in the US that could fuel capital markets even further and whilst there were some geopolitical fizzles, these were nothing compared to the strong rhetoric we are seeing nowadays.
The much anticipated European elections turned out to be non-events (a positive for investors: markets hate surprises but love stability and predictability). As a result, 2017 turned out to be a year which saw a global synchronised upswing that delivered very solid investment returns in virtually all asset classes and as such, "momentum investing" was the name of the game: whatever you do, it's highly likely to go up.
At the beginning of this year, the general consensus was that 2018 would see a continuation of this global synchronised upswing with similar global growth, although the expectation was that there would be more regional differences, with emerging markets seeing the biggest gains.
And indeed, the markets got off to a good start, with January and most of February showing strong investment returns. At the end of February, however, a first shock was delivered to the system, with a sell-off in the global equity markets, losing the gains of the first few weeks of 2018 and a huge spike in volatility (as measured by the VIX Index) was the result. Although markets have calmed down since, the level of uncertainty surrounding the markets has increased tremendously and more importantly, to a great extent unexpectedly. And generally speaking, investors hate uncertainty.
Let's first take a look at these uncertainties and there's a lot of them.
The most obvious is the looming potential trade war. While it is conventional wisdom that trade wars (countries imposing punitive tariffs on each other's goods) only have losers and actually caused the Great Depression in the 1930s, US President Donald Trump has a different opinion and seems to prefer rhetoric over rationale. The ultimate outcome is unknown but current signs are that it is spiralling out of control. Many countries are putting in place retaliatory measures against the US as we speak, most probably triggering counter reactions.
Then there's Europe. Germany seems less stable than usual and then there's Italy.
France's De Gaulle once wondered how he could govern a country with 246 varieties of cheese. Italy has 487 types of cheese…Uncertainty from Italy, Europe's third largest economy, is currently rattling the markets.
Next up: the Middle East. Unrest in Syria, uncertainty around the Iran nuclear deal, the Saudi-led coalition in Yemen and the clashes between Israel and the Palestinians. The list goes on.
But mostly, the US, a beacon of stability for many decades, is reversing this trend at a staggering pace, upsetting not only its foes but also almost all of its long term allies.
Pulling out of the Paris agreement on climate change, cancelling trade agreements, the Iran nuclear deal and more recently, withdrawing from the United Nations Human Rights Council, to name just a few.
So the question is: Where do you go from here? What do you do as an investor facing all these unfolding global events?
Our advice is to "keep calm and carry on investing". Global growth is still healthy, corporate earnings are globally strong and unemployment is at a low or even all-time low levels in most developed economies. Whilst interest rates are on the rise, central banks are more transparent and predictive than ever before, so markets have fully priced in central banks' policy on rising interest rates.
As for trade, so far this year, Asian exports are up. Trade continues to expand at double digit rates -- not a sign of a global slowdown yet.
America's diplomatic advances to North Korea are, as it seems at this stage, a reasonable first step and ultimately,stability on the Korean peninsula would benefit regional stability. While it is early days and the potential economic effects of this détente might not be felt for years to come, the psychological effect on financial markets so far is positive.
Having said all that, this is typically a time when investors need to keep "a close eye on the ball". And in order to ensure that you continue to see the woods through the trees, regular sparring with your financial advisor(s) is, in my view, a must. So make sure you monitor your portfolio together more regularly than usual so that adjustments can be made in a more timely manner, as and when needed.
My view at this moment is the following: make gold (XAU) part of your portfolio, even if it's just a small portion. In general, shorten the duration of your fixed income portfolio. Unless you have a very long investment horizon (10 years or more), liquidity is important in order to act quickly, if needed, so I'd advise to stay away from the more illiquid securities at this stage.
Hedge part of your portfolio, whatever is in there. This ensures you'll be able to sleep at night, whatever the markets are up to! And I risk stating the obvious: ensure diversification and keep your risk tolerance in mind!
- The writer is head of Markets, Investments & Structuring, Asia, Indosuez Wealth Management