What do geopolitical tensions mean for markets?

Right now it seems much of the headline news is about some form of tension between countries. As these tensions materialise, they often impact economic activity and investors’ confidence in share markets. So what do geopolitical tensions mean for your super?

What is geopolitics and what are geopolitical tensions?

Geopolitics focuses on political power linked to geographic space, and is usually just another way of saying international political relations. Put simply, geopolitics refers to political factors that are between countries/regions. For example, politics between the US and China or, more recently, Russia and Ukraine. Geopolitical tensions are exactly what they sound like — political issues between or involving 2 or more countries that cause tension or unrest. These tensions can stem from several factors, but some examples are power, trade, military activity, climate change or a significant event like Brexit.

Current tensions

Russia-Ukraine tensions have occupied the headline news recently. Russia officially recognised two separatist states in Eastern Ukraine and ordered troops into the area on Monday. The move has further escalated the situation and the US, Europe and Australia immediately announced sanctions on Russia on Wednesday.¹ The first tranche of sanctions is generally deemed as moderate; there is still a high possibility that more serious sanctions are on the way if Russia continues marching in its current direction.

How does geopolitics affect economies and investment markets?

It’s no surprise that geopolitical tensions cause uncertainty, both in the economy and for investment markets.

When in a period of geopolitical tension, it’s not uncommon to see delays in decision-making from businesses and individuals. For example, a business may put in place a hiring freeze or a family might delay purchasing a new car or house for fear of the unknown — it’s human nature. These little shifts in behaviour, if prolonged, can influence the way an economy grows and thrives. From an investment market point of view, the uncertainty can result in risk aversion behaviour and volatility.

Looking back over 29 past geopolitical incidences, we observe that markets are both volatile and negative in the short term following the initial trigger event, but recover quickly. For example, after one year of a geopolitical event, 83% of the time, markets return positively, with an average of 12.3%.

So we can make some assumptions based on history, but given that no geopolitical event is precisely the same as another, the exact path that share markets and economic activity will take is difficult to predict.

History also shows that bear markets do not usually follow a geopolitical event involving a military conflict. Usually declines are short-lived (far below the 20% drawdown that is the threshold for a bear market). After forming a bottom, markets tend to resume their uptrend. The table below shows events in the recent past.

Source: MSCI Inc. and Thomson Reuters Datastream. MSCI data provided "as is" without any express or implied warranties.
Notes: Data reflect MSCI All Country World from February 1988 to present and MSCI World prior to February 1988. All returns reflect price changes in US dollars.

Conclusion

Super is a long-term investment and decisions around switching and future contributions should be carefully considered. The NGS Super Investments team adopts a diversified approach to portfolio construction and utilises tools to dynamically shift allocations during negative market events to smooth the effect of declines. In addition, there are specific asset classes in which NGS Super invests, such as gold, which increase in value during such times and offset some of the declines in equity markets. In fact, the gold price has increased by approximately 4.5% since the beginning of this year, partially offsetting the equity market corrections.