On the day the launch of an investigation on the US President’s Russian ties was announced, global equities lost circa 2% of their value. Was this a game changer, or was it a catalyst for equities to take a much overdue breather?
The world of investment analysis is dominated by large amounts of economic and financial data. Global markets mostly move on earnings reports, valuation multiples and, on occasion, larger macroeconomic trends. However, due to the gargantuan quantity of often conflicting data, most of which is not very newsworthy, financial publications are often disposed towards assigning a disproportionate part of their headlines to geopolitics which tend to generate more discussions (and clicks).
To be sure, politics does have some effect on market prices. Bank bailouts and Quantitative Easing, which were in large part politically driven, rescued global financial assets in 2009, initiating an unprecedented rally. The 2003 war in Iraq had a well-documented positive effect restarting the US economy. Mr. Trump’s elevation in office in conjunction with the Republican sweep in Congress, broke a 6-year long gridlock in Washington propelling equity prices to new highs. Brexit drove the Pound down nearly 12%. On the other hand, Putin’s occupation of Crimea, the Italian referendum and the Dutch election had very little effect on global markets.
Going forward we aim to issue a geopolitical update about the major issues facing the global economies. The focus will be on analysis and potential market impact, rather than attempting to predict the outcome of those events.
Will Trump remain as POTUS?
After Mr. Trump fired the FBI’s director, the New York Times reported that James Comey was in possession of a memo suggesting that he was pressured by the President to end the investigation of his Russian connections. If proven, this may constitute obstruction of justice, which is classified as a felony. The President additionally shocked the intelligence community when he used executive privilege to share classified information with the Russian ambassador Sergei Lavrov. The Comey affair is the latest and more severe in a series of missteps by the White House, which led to the appointment of a special prosecutor, former FBI director Robert Mueller, at the helm of an investigation aimed at revealing any possible wrongdoing. However, whatever the outcome of this inquiry, ousting the President is no simple feat. In the history of the United States only one President has been forced to resign, Richard Nixon in 1974. Even after the revelations, Mr. Trump enjoys the support of 84% of Republican voters and the Republican Party has a demanding legislative agenda before the next mid-term election, including the Obamacare repeal, Wall St. deregulation as well as an increase in infrastructure spending. Republican lawmakers are now faced with a choice: get bogged down with talks about impeaching their own President (obstruction of justice may be very difficult to prove) and risk alienating their base, or focus on their legislative work as means to get re-elected. The path they choose could have significant market effect. Market risk level: 5/10
Will North Korea be a problem?
Kim Jong Un’s regime announced the successful launch of a mid-range ballistic missile last week, which brings it closer to its strategic goal: the ability to launch an nuclear strike on US soil. The US’s express goal is to prevent this from happening, but it can’t intervene without upsetting China, N. Korea’s strategic ally. Still, it is hard to fathom that the world’s premier Superpower would allow Kimthe capability of a first strike. US policy has been steadfast in this direction ever since the Cuban missile crisis in the early 60’s. We feel that market impact of this is likely to be minimal, if any at all, unless North Korea actually attacks the US. It is a binary scenario, with very little probability of actually upsetting the markets. Market risk level: 1/10
Will the general election affect Brexit?
When Ms. May announced the snap election on June 8th, the GBP rallied, as experts believe that this elevates the probability that the PM will be more free to negotiate a trade agreement if she gets an increased majority.. Additionally, the European Court of Justice’s decision that the European Union does not need to seek ratification of a trade deal by the EU’s 38 national and local parliaments, affords their European counterparts that same flexibility. Away from national parliament and public scrutiny a deal would probably be more easily struck. We await the election results with anticipation. The risk, in this particular case, is a government that will not have the necessary parliamentary majority to negotiate unimpeded, whereupon the GBP could give up its recent gains. Recent polls suggested that Labour was narrowing the gap with Tories, with only 3 weeks to go, but that momentum may have been halted as of late. Market risk level: 3/10 (contained to UK risk assets).
Will the Euro implode?
After successfully fending off populist upsets in the Netherlands and France, the Eurozone is now much calmer and its leaders are focusing on four big issues: the German general election in November, the Italian bank recapitalisation, Greek debt and Brexit. Brexit is of little immediate consequence for European markets but it could have an effect on the Euro which would in turn impact the group’s exports. The Greek debt issue is potentially damaging but the Eurozone has done a superb job kicking the can down the road so far, without offering debt relief or letting the country default on its obligations. The German general election has little potential to disrupt markets. Even if SPD leader Martin Schultz wins the election (more unlikely now than two months ago), market reaction would probably be muted as all realistic candidates are pro-Europe. The real thorny issue is that of the Italian bank recapitalisation. Monte dei Paschi’s Chairman Alessandro Falciai said recently he remained optimistic over the outcome of the Italian bank’s request for a state recapitalization needed to fill an 8.8 billion euro capital shortfall. However, new rules insist on a bail-in before a state bail-out, which would mean serious haircuts for creditors, many of whom bought bank bonds in lieu of deposits. This sets the scene for a confrontation between Italy, one of the world’s largest debtors and the rest of the Eurozone core countries. The Euro is a deeply flawed monetary union and any number of reasons can trigger its demise, an event that could potentially have a vastly larger impact than the demise of Lehman Brothers. The key to its resilience is the European Central Bank. So investors should be on the lookout for clues that the central bank may unexpectedly change direction and not do “whatever it takes” to defend the Euro, before calling the end of the Eurozone. Market risk: 3/10.
What other geopolitical issues might affect markets?
In China, the conclusion of the 19th National Congress in autumn (where a majority of the Politburo Standing Committee, the top decision-making body, is expected to retire), should unlock further developments such as the much touted Belt and Road initiative, a huge infrastructure undertaking to produce a modern-day “Silk Road”. This could considerably stimulate the Chinese economy but the effect is more long term.
Fears and Flows 