Geopolitical risk has once again become a concern for many investors. Recent surveys from the last week in September, such as those conducted by fund managers and the AAII Sentiment Index, indicate that investors across the board are increasingly anxious about global instability on multiple fronts. This trend is not limited to the United States. According to the latest Systemic Risk Survey from the Bank of England, the vast majority of UK financial services firms identified geopolitical risk as a significant threat, with all surveys showing an uptick in concern since the start of the year. Notably, these surveys were conducted before recent escalations, suggesting that investor anxiety may be even higher now.
The recent tensions between Israel and Iran have triggered several typical short-term market reactions, including increases in crude oil prices, gold, and the Volatility Index (VIX), while global bond yields and equities declined. While short-term adjustments can help protect against, or even capitalize on, immediate volatility, long-term strategists more often factor geopolitical risk into a broader risk management framework that aligns with strategic asset allocation.
Historical analysis of geopolitical upheavals and their effects on financial markets reveals some consistent patterns. Geopolitical events- ranging from wars and terrorist attacks to political assassinations- rarely emerge as major market drivers. However, it is important to recognize the potential for secondary effects, such as an overreliance on adversarial foreign powers for critical energy supplies. Additionally, prolonged conflict is typically unfavorable for business and can fuel inflationary pressures as energy and agricultural supply chains can be disrupted. Nevertheless, historical evidence suggests that, after an initial shock, markets tend to revert to their prevailing trends.
Another significant political disruption worth noting is the ongoing dockworkers’ strike in the U.S. This is the first strike of its kind since 1977, while much progress has been reported, it is still effectively shutting down about half of the nation’s ocean shipping capacity. While the strike has had a limited impact thus far, with many companies overstocked and utilizing alternative supply routes like air freight, this more expensive option could lead to backlogs if the strike continues, ultimately causing greater disruption.
The positive news is that as a global economy, we have moved beyond imminent inflationary concerns, and central banks appear prepared to coordinate a response in the event of a material economic slowdown. However, the consequences of any significant supply chain disruption remain uncertain. Bernard Mensah of Bank of America noted that a sustained increase in friction in global supply systems could lead to a slightly higher underlying inflation rate. If that were to happen, investors should not expect interest rates to return to the ultra-low levels of recent years. In summary, while central banks may refrain from raising rates in a disruption due to the potential for a slowing economy, they may also hesitate to lower them if inflationary pressures persist.
While these events are devastating for those directly impacted, and there is some risk that global oil flows could be disrupted if the conflict escalates, investors should be thinking about how the long-term direction of geopolitics might affect their overall allocation and consider hedging strategies where appropriate. Most importantly, anticipating the direction of war or reacting to headlines rarely yields positive results. In fact, history suggests that buying into times of uncertainty often produces better long-term outcomes.
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