How to play risk events this year
Risks aren’t going away – in fact, the risk of a share market correction is only likely to increase this year according to Dr Shane Oliver. Here, Shane shares his view on how to play these risks, along with a list of key events and expectations for investors to keep an eye on this year.
Risks aren’t going away. In fact, the risk of a share market correction on the back of a global event is only likely to increase this year.
However, cowering in fear is not the best way to account for increased risks facing global share markets in my view.
We know that SMSF investors are particularly concerned about the geopolitical environment. Given the difficulties in trying to predict geopolitical shocks and their impact however, it often makes more sense for investors to focus on the investment opportunities they throw up, rather than taking long term shelter from them in low-returning cash.
To be able to do this, it’s important for investors to be attuned to the shifts and dips likely to be associated with geopolitical risks.
This year, and into the future, I see a few reasons investors should be more attuned to geopolitical events perhaps more than they have been in the past.
First, in the slow post-global financial crisis recovery, rising inequality and stress around immigration have all led to a backlash against establishment politics and economic rationalist policies. This is showing up in support for re-regulation, nationalisation, increased taxes and protectionism and other populist responses, which could slow growth and share markets.
Second, the relative decline of US economic and military power is shifting us away from the unipolar world that dominated after the Cold War when the US was the global cop and most countries were moving to become free market democracies. We are now seeing the rise of China, Russia revisiting its Soviet past, and efforts by other countries to fill the gap left by the US in parts of the world, all creating tensions.
Third, social media is allowing us to make our own reality. The danger is that, as politicians pander to this, economic policy making will be less rational and more populist.
Sure, geopolitical events like Brexit and Donald Trump’s election in the US may have surprised investors in 2016, but they had no lasting negative impact on global financial markets.
By last year, investors were perhaps hyper-focussed on geopolitical risks – Trump taking over as US President, Eurozone elections, the Communist Party Congress in China and rising risks around North Korea – but again they did not have much lasting negative financial market impact. In fact, in most cases it turned out to be a positive impact.
Now in 2018 it’s already clear that geopolitical events remain significant, for example with Trump’s tariffs and the messy Italian election result.
Despite their benign financial market impact to date, geopolitical risks are worth keeping an eye on in my view and thought about in the context of the opportunities they may create.
Here is a list of the events coming down the pipeline investors should be aware of and a thought to what investors should expect:
Trump faces two big challenges this year. First, the mid-term Congressional elections in November risk the Republicans losing control of the House and also the Mueller inquiry is closing in. These in turn put pressure on Trump to create distractions and return to focussing on his base after the pro-business focus of last year. The tariffs, dealing with North Korea and maybe Iran fit into this.
Much has been written about Trump’s steel and aluminium tariffs, but a full-on global trade war is unlikely. First the steel and aluminium tariffs are trivial amounting to less than 2 per cent of US imports. They are nothing compared to the tariff hikes of 1930 and 1971 that covered most US imports. Second, there is more to go on trade with NAFTA renegotiations, a review of China’s alleged theft of US intellectual property likely to result in broad tariffs on US imports from China and restrictions on Chinese investment in the US and possible tariffs on vehicles, shipbuilding, aircraft and semi-conductors are also possible.
US shutdown risk
By March 23, funding will again have to be renewed for the Government to avoid a shutdown. But neither side wants to be blamed for a shutdown so expect funding to be granted, another extension or any shutdown to be brief.
The US deadline to remain compliant with the Iran nuclear deal expires in May. It will probably be renewed but if it’s not and sanctions on Iran return it potentially means a sharp reduction in Iranian oil supply which could put upwards pressure on oil prices.
Italy and Europe
The messy Italian election outcome is not great for Italy, but it’s unlikely to threaten the Euro. There are now three major blocs in the Italian lower house. None of these blocs are near a majority and it may require a new election.
The impact of terrorism on investment markets has been declining since the 9/11 attacks to the point where attacks in recent years have had little impact. Economies and markets seem to have become desensitised to them to a degree.
The Chinese Government’s focus on its reform agenda - shifting towards less investment intensive growth, reducing pollution, reforming state-owned enterprises and reducing financial risk - has long run hot and cold, speeding up in good times only to slow down if growth slowed.
The main risk in Australia is an early election and the adoption of less business-friendly policies (higher taxes, more regulation) under a Labor Government, which may be taken badly by financial markets.