Stocks Show Little Geopolitical Worry After $16 Trillion Rally
And the Federal Reserve’s interest-rate cut this week has all but cemented confidence on further gains into the year end.
(Bloomberg) — It’s long been a somewhat unseemly fact about financial markets: They, and the humans who make them whir, must be dispassionate when it comes to the affairs of the world.
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Take the state of play right now: Equities are at record highs after a rally that added $16 trillion in market value this year, oil is near the lowest levels of the last four years, and risk taking abounds in everything from cryptocurrencies to meme stocks. Expected volatility in the US stock market is hovering around one-year lows.
All while Russia has sent drones into NATO airspace, Israel presses a ground assault on Gaza and Japan’s government teeters along with the one in France — again. Ukraine remains under siege. China continues to eye control of waters around Taiwan. And President Donald Trump prosecutes an unorthodox trade war against friend and foe alike.
While geopolitical risks are undoubtedly increasing around the world, the playbook for investors remains the same: Keep an eye on it, but don’t fret unless politics and humanitarian disasters affect economic forecasts or asset prices like oil.
“We’re very focused on geopolitical risks, but as an investor you’ve got to look at how you can quantify that,” said Helen Jewell, chief investment officer of EMEA fundamental equities at BlackRock Inc. “It is the implication on consumers and currency because they are the things that impact company earnings, and they are a little bit more difficult to exactly model out.”
Corporate earnings have indeed remained robust this year, while the US economy continues to evade a recession. And the Federal Reserve’s interest-rate cut this week has all but cemented confidence on further gains into the year end.
But a flare-up in those hot spots — and others that aren’t even on the radar at the moment — would derail that optimism in a flash if, say, oil prices spiked or a major nation’s sovereign bonds tumbled.
That’s what happened in 2022, when Russia launched its full-scale invasion of Ukraine and crude prices soared. Wobbly governments in developed economies like Japan and France also make their bond markets susceptible to pressure, which would have negative consequences for global equity benchmarks.
“Little has been priced into stocks on geopolitical risks,” said Guillaume Jaisson, a strategist at Goldman Sachs Group Inc. “The US market has rarely been more expensive, and even Europe is absolutely not cheap.”
Policy Shock
Trump’s impulsive policymaking has already provided a glimpse of the scale of the damage that’s possible. The S&P 500 Index sank almost 20% from peak to trough this year as the president threatened the highest tariffs in a century in April, the dollar’s status as a global reserve currency was questioned and a flight from Treasuries sparked a debate around the end of US exceptionalism.
In other parts of the world, too, markets have been roiled by geopolitical unrest. France’s CAC 40 Index tumbled more than 3% in the two days after former Prime Minister Francois Bayrou called a vote of confidence over a budget showdown last month. Foreign investors have pulled about $473 million from Indonesia’s stock market this month amid violent protests and the abrupt replacement of the finance minister.
Japanese markets also face more volatility after Prime Minister Shigeru Ishiba announced his plan to step down.
However, the pessimism has generally tended to be short-lived as investors bet governments and central banks stand ready to protect both the economy and markets from a prolonged downturn.
“If you have a pickup in uncertainty, we would expect this environment of ‘bad news is good news’ to change to ‘bad news is bad news,’” Goldman’s Jaisson said. “There is little scope to disappoint.”
Viktor Shvets, a global strategist at Macquarie, said equity investors have historically struggled to account for geopolitical risk, and instead “put a high premium on structural aspects” such as corporate profits and household finances.
“Equity investors are hopeless about geopolitics; since the Vietnam War, it hasn’t had an impact,” Shvets said.
Lingering Fallout
Looking at the market’s performance from a wider lens, though, suggests geopolitical turmoil can sometimes have a longer-lasting impact.
The CAC 40 has underperformed both European and US peers since French President Emmanuel Macron called a snap election in June 2024, missing out on a global rally spurred by bets on artificial intelligence and resilient economic growth. And in the UK, the FTSE 100 has trailed international benchmarks in dollar terms after the Brexit referendum in 2016.
There are also signs that investors are starting to get nervous about the possibility of a further escalation in conflicts as well as political turmoil. A Bank of America Corp. survey showed geopolitical risk rose to the highest level since December in fund managers’ ratings of potential threats to financial market stability.
In equity markets, sectors that are exposed to geopolitical risk have reacted this year, with a UBS Group AG basket of stocks that stand to benefit from higher European defense spending rallying more than 100%. Gold — a traditionally haven asset — is scaling record highs, although part of that has been driven by the slump in the dollar.
“If turmoil does become a threat to economic activity, there is significant downside for equities because stock valuations are currently well above historical averages,” said Tim Murray, a capital market strategist in the multiasset division at T. Rowe Price Group Inc. “A big negative economic surprise — be it politically driven or not — could mean a much bigger selloff than normal given the current valuations.”
–With assistance from Julien Ponthus and Michael Msika.
