Geopolitical risks for investors

by David Joy, Chief Market Strategist, Ameriprise Financial

Key Points

  • A variety of headline events are grabbing investors’ attention in 2019.
  • Issues from trade disputes to the risk of military conflict are a major distraction for the markets.
  • The potential impact of these events varies, but don’t be caught off guard.

Investors rightly place most of their attention on fundamental factors, such as the pace of economic growth, corporate earnings and interest rates — typically primary drivers of asset prices — as they make decisions about their portfolios. But they must also be mindful of other factors that can affect asset prices, including current events making headlines and the influence of geography, or geopolitics. This has been especially true in 2019.

Global trade in the spotlight

The ongoing trade dispute between the United States and China is the single most influential external factor currently affecting investment markets. While geography may be less important in this dispute, the competition for global influence between the two nations certainly plays a role.

The U.S.’s decision to impose tariffs on Chinese imports was designed to pressure China into negotiations with the U.S. over what it views as unfair trade practices. These include forced technology transfers, intellectual property theft and less-than-full access to China’s domestic markets for many U.S. companies.

The on-again, off-again negotiations most recently broke down in early May, and both sides imposed higher tariffs. However, talks have now resumed. Existing tariffs remain in place, but new tariffs were put on hold indefinitely.

There is an economic cost to the trade war, especially for manufacturers whose supply chains are disrupted and for U.S. companies with heavy sales exposure to China. The increased cost has been mostly absorbed by U.S. consumers. Global trade and economic growth slowed. Yet, President Trump enjoys bi-partisan support for confronting China on trade — and for doing so at a time when the economy is generally healthy and better able to absorb the impact on growth.

We estimate that if the status quo on tariffs holds through year-end, it could reduce U.S. economic growth by approximately 0.2% to 0.3%. That is already significant, and if negotiations yield little progress, things could get worse.

On the other hand, a credible agreement would likely provide a welcome relief rally in the stock market along with a burst of economic optimism. This is an issue that we believe investors will closely watch through the rest of 2019 and possibly beyond.

Another trade uncertainty concerns a U.S. threat to impose tariffs on automobile imports under the umbrella of national security. The U.S. has postponed this decision for six months, much to the relief of Japan, Germany and other exporters and suppliers. The U.S. and European Union (EU) are also at odds currently over government subsidies for aircraft production.

Additional overseas conflicts possible

Geography plays a prominent role in another geopolitical hotspot, namely the Persian Gulf, where tensions between the U.S. and Iran have increased. In an effort to halt what it calls Iran’s state sponsorship of rebel forces in the Middle East, the U.S. pulled out of the 2015 Iran nuclear agreement and imposed a series of sanctions designed to cripple Iran’s ability to sell oil to global markets. Oil accounts for roughly 40% of the Iranian government’s revenue.

Iran’s economy is feeling the effects, and tensions are rising. Recently, Iran announced plans to boost its uranium stockpile above the limits set in the 2015 agreement, while the U.S. vows to prevent Iran from obtaining nuclear weapons capability entirely. So far, the price of oil has risen only modestly in response to the increase in tensions, as other factors have kept oil prices stable.

Another center of geopolitical risk is North Korea. The U.S. wants North Korea to denuclearize. Talks seem to be underway once again following President Trump’s visit to North Korea, and China is likely to have significant influence as to the direction negotiations take. The North Korean economy is reportedly in desperate need of aid, as U.S. sanctions deprive it of revenue.

Europe’s future hangs in the balance

Although not raising military concerns, the uncertain outcome of Brexit, Britain’s departure from the European Union, continues to hang over the EU and world economy. Great Britain is getting a new prime minister, just as the EU gets its own new leadership team. Britain’s economy has managed to grow at a moderate pace, but the new Brexit deadline is Oct. 31, and a “no-deal” exit (Britain leaving without a trade relationship with the EU) remains a distinct possibility. That could add to the sense of economic uncertainty.

Make sure your investments are well-positioned

The impact of geopolitical events on markets is typically temporary, although in some cases, such as a war, the repercussions can last for years. Certain risks and their potential impact are easier to foresee than others. Such is the case with the trade dispute with China. We do not know how it will end, but it is possible to approximate its economic impact under a range of scenarios.

Conversely, the impacts of other geopolitical risks are more difficult to project. The possibilities of military conflict with Iran or North Korea are examples. While many may consider these to be low-probability events, they cannot be completely dismissed. The extent to which markets might react to such events is uncertain.

The best protection against geopolitical uncertainty is a well-diversified portfolio, although if a military conflict occurs, risk assets overall would likely come under pressure, at least temporarily. At such times, so-called safe-haven assets, historical stores of value to which investors retreat in times of uncertainty, could add a degree of protection. These may include cash, Treasury securities, defensive equity sectors and gold.

Center your discussion with your financial advisor around where your portfolio stands currently and how it is built to weather ups and downs that happen in response to geopolitical events. Explore potential steps to consider if certain external events begin to impact the markets beyond the short term.