Politics and geopolitics are polarizing and confusing. Yet it is critical that investors integrate such criteria into their analysis.
“[Investors] absolutely should be paying attention to geopolitics,” said Willis Sparks, the director of global macro at Eurasia Group, in an interview with Jason Voss, CFA. “It’s a complicated issue and you really have to look at it issue by issue, market by market. But absolutely politics is increasingly important for both developed and emerging-market countries.”
In less mature markets, politics tends to have a bigger influence on outcomes, he said. But developed nations aren’t immune to political turmoil that can spill into markets. For example, Sparks referenced President Barack Obama’s decision to bail out the auto industry during the recession.
Sparks went on to stress how vital it is to prepare for potential geopolitical events while remaining objective.
Political Knowledge as a Competitive Advantage
So what’s the payoff of a geopolitical focus?
“There is alpha in it,” Sparks said, “if your better understanding . . . gives you a competitive advantage.”
The goal, according to Sparks, is to grasp the political risks so you can identify where they are exaggerated and where they are underappreciated. Is North Korea’s latest missile test seriously destabilizing or is it much ado about nothing? If you have insight into that, you can prepare accordingly and hopefully reap the returns.
For example, Sparks predicted Donald Trump would lose the 2016 presidential election, but he wrote about what policy might look like under a Trump administration. Because Sparks planned for the unexpected outcome, his investors were better off when it actually occurred.
“Even though we were wrong with our forecast,” he said, “our clients were well-prepared by the scenarios.”
Political Uncertainty and Its Effects on Finance
So what are the geopolitical trends that most concern Sparks?
He voiced some worry about Europe, explaining that the current atmosphere will have both short-term and long-term effects. He is watching Brexit-related uncertainty, the growth of populist movements in Italy, and friction between Turkey and the European Union — and planning for every scenario and outcome.
In Asia, Sparks said he is keeping a close eye on China, which he thinks will need stability over the next year as top officials begin to rotate out.
The largest threat may be North Korea, Sparks said, specifically its ability to launch an intercontinental ballistic missile, which could lead to a war on the peninsula. The toll of such a conflict is impossible to calculate. The potential price tag of reconstruction alone would be astronomical. “The cost of cleanup is going to be historic,” he said. “It’s not clear who is going to pay for it.”
And cleanup would be only part of the dilemma. “There’s 20 million North Koreans who are going to be completely lost when they emerge into this new world,” Sparks said. “And somebody’s got to pay to try to create enough parity of prosperity between North and South Korea to create a stable peninsula. It’s going to take 40 or 50 years. And who’s going to pay?”
A potential conflict with North Korea would involve complicated diplomacy among the United States, China, and other nations. The result of these diplomatic discussions, whether it involves tough sanctions, cyber and covert operations, or military action, is going to be expensive. And the outcome is effectively unknowable.
But Sparks embraces this uncertainty.
“You have to be able to get past partisan politics,” he said. “You have to be able to drill down into what’s actually happening, why is it happening. You have to put your prejudices aside, which is a full-time job.”
Sparks had one last piece of advice: “Question your assumptions all the time, and be rigorous about it.”
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All posts are the opinion of the author. As such, they should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute or the author’s employer.
Image credit: ©Getty Images/Han Myung-Gu/Stringer
source https://capitalisthq.com/geopolitical-uncertainty-in-investing-plan-for-every-scenario/
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