Heightened geo-political tension may disrupt global trade flows and distort commodity prices

Geo-political tension – opportunity or threat?

The war on Ukraine and the conflict between Israel and Hamas in the Middle East, made more complex by the recent missile attack on Israel by Iran, has heightened global political tension. This elevated geo-political tension has increased share market volatility in recent days and is adding a note of caution to macro- economic forecasts as the level of uncertainty rises in these times.

Geo-political tensions are often accompanied by the imposition of international trade and financial restrictions that may inhibit cross-border credit and investment flows. On the trade side, tensions between countries can disrupt trade flows and cause supply chain bottlenecks around the world, including in third-party countries not directly affected by the geo-political tension. For example, militants have been attacking ships in the Red Sea and the Gulf of Aden in a campaign sympathetic to Palestinians and opposed to Israel’s continuing war on Gaza. Unsurprisingly, these attacks have coincided with higher oil prices in recent weeks. Trade restrictions also affect commodity prices and may lead to shortages of key resources, affecting global industrial production.

In terms of financial markets, the impact of financial sanctions can increase banks’ debt rollover risks and lead to higher funding costs. Geo-political tensions can also be transmitted to banks through the real economy if economic activity levels decline leading to higher unemployment and increased bad debts arising from credit defaults on bank loans. Even if higher defaults do not occur, less risk-taking by banks may result in tighter credit, prompting banks to curtail lending activity, weighing on economic growth. This may have a contagion effect where other decision-makers such as governments, large (and small) businesses, investors and importantly consumers, may delay their investment decisions. Businesses may post-pone capital investment decisions or making new hires, consumers may delay spending on items such as cars or houses, while financial investors become risk averse and direct more of their portfolio to government bonds, bank deposits or gold.

However, experienced investors have dealt with global conflicts in the past by remaining invested but with an emphasis on investments that are asset-backed (like property trusts or infrastructure assets) or commodity producers, utility stocks, consumer staples and the healthcare sector. These investments tend to have a Beta value of 1.0 or less, which means that their security price is theoretically less volatile that the overall market.

Buy the rumour, sell the fact

History shows that economic activity and financial markets are often more affected by geopolitical threats than by actual events.

The threat of all-out war or escalation of a political crisis or the potential imposition of trade sanctions tend to increase investor uncertainty and downside risks, while actual events tend to resolve uncertainty and prompt protective policy responses. This market phenomenon is the basis of the stock market adage to “buy the rumour, sell the fact”. In other words, savvy and patient investors buy or remain invested during uncertain times and before all the facts are known.

Buying shares in the face of uncertainty comes with a discount, and that is the upside to be captured once the facts become known or clarity quantifies the potential loss. Sellers in times of distress aren’t considering value, they’re simply focused on going to cash at any price This is why in times of uncertainty and share price volatility the crowd doesn’t make money…………………. but individuals do!

‘Buy the rumour and sell the fact’ explains why share prices sometimes fall after a positive announcement. Once the facts are known, savvy investors often sell, take their money, and lock in profits because everything is obvious once it’s already happened.

So, geo-political tension does create share price volatility, but also presents opportunities for patient investors with a balanced share portfolio. Experienced investors know that market volatility is the simply the price investors pay for the long-term outperformance of shares.