With the rise of globalization, the world economy is no longer constrained by political borders. This global interconnectedness provides many benefits but can also create new challenges. One of these challenges is political risk.
International disputes in one area of the world can have widespread implications for businesses and investors thousands of miles away. However, shifts in investment markets related to geopolitical events are often short-lived and may not impact all assets equally.
It is important for investors to understand which assets carry geopolitical risk and how the current global environment could impact their portfolios. With this information in hand, you can make financial decisions that set you up for future success – while minimizing unnecessary risk.
Why do political events around the world impact U.S. markets?
In an increasingly globalized world, many U.S. companies source materials, employ labor, and sell products in foreign countries. Geopolitical turmoil can disrupt supply lines and halt manufacturing in affected countries which can have significant ramifications for U.S. companies. Additionally, sanctions and trade bans can prevent U.S. companies from selling their products in foreign markets and prevent U.S. consumers from buying foreign products.
In some cases, there is a clear aggressor in geopolitical events and both governments and individual companies may cut ties with that country. This is the case today, following Russia’s invasion of Ukraine. The U.S. and its allies recently imposed sanctions on the Russian economy, and dozens of companies have taken action to minimize trade with Russia. These include car manufacturers like Jaguar, Volvo, Ford and GM, energy companies like Shell, BP, and ExxonMobil, and tech giants like Apple, Meta, and Google. These sanctions and company boycotts will have spillover effects into the U.S. economy.
During the past several decades, Russia has been a significant trade partner for the United States. For reference, in 2019 U.S. companies exported $10.9 billion in products to Russia including machinery, aircraft, vehicles, and medical instruments. The same year, $24.0 billion in goods including mineral fuels, precious metals, iron and steel, and chemicals and fertilizers were imported into the U.S.
Companies that have exported goods to Russia in the past could see lower revenue as they lose that portion of their market. Also, companies that rely on imports from Russia could see delays or even a halt in manufacturing and higher prices for the commodities they import.
Stocks Could React to Geopolitical Uncertainty
During geopolitical turmoil, individual companies that rely on foreign inputs or sell their products in foreign markets could see higher costs and lower revenue. This impact on a company’s bottom line could flow through to their stock prices.
An additional factor that can negatively impact the stock market is the perceived risk during geopolitical turbulence. This is due in part to investor sentiment. When investors believe that future cash flows might be impacted, they tend to shift their investments away from stocks and to other types of assets. This can result in losses across the board for stocks, even those that are not directly tied to the area experiencing the turmoil.
As expected, the current geopolitical environment has led to turbulence in U.S. stock markets. In the days leading up to Russia’s invasion, stocks tumbled. But, after the U.S. and European allies announced sanctions against Russia, the markets recovered some of the losses. In the days since, markets have continued to show severe volatility.
Geopolitical Shocks Are Often Short Lived
When geopolitical events take place anywhere in the world, U.S. stock markets tend to dip. However, these shocks are often short-lived. For example, when the Iraq War began in 2003, the S&P 500 fell by 0.5% in the first week. But after three months the index had rallied, posting a gain of 15.7%. One year after the war began, the S&P 500 was trading 28.4% higher.
In other geopolitical crises, the S&P 500 followed a similar pattern. Following 66% of geopolitical events since WWII, the S&P 500 has returned to positive territory within one month. In 83% of cases, the index had a positive return one year after a geopolitical event.
Investors Seek Safety in Uncertain Times
Stocks are generally viewed as riskier investments compared to some alternatives. When geopolitical risk increases, stock investors often turn to assets that are perceived as safer, like bonds. This influx of new buyers can drive down bond yields. In the current geopolitical climate, this has proven to be the case.
After Russia invaded Ukraine, the yield on the 10-year Treasury note dropped to 1.7% from where it had been trading around 2.0%. Since bond prices move counter to bond yields, investors could see higher resale values for their bond holdings if yields continue to fall.
How Can Investors Mitigate Geopolitical Risk?
Fortunately for investors, geopolitical turbulence typically eases quickly. However, you may be wondering what you can do to prepare for global turmoil. Here are some steps you can take:
Remain Focused on Your Goals
In the past, geopolitical events have not had long-lasting effects on investments. While past performance doesn’t guarantee that the markets will react the same way in the future, it is the best indicator available. So, in most cases, it doesn’t make sense to divest your portfolio based on the geopolitical climate. Instead, focus on your goals and review your plan with an experienced financial professional to ensure you’re properly positioned.
Ensure Your Portfolio is Diversified
Diversification is key to mitigating risk in your portfolio, and geopolitical risk is no exception. This strategy involves spreading your investments across multiple asset classes and investment types so that when one asset loses value, the others tend to maintain their value or grow.
Through diversification, you can mitigate geopolitical risk by investing in assets that are not as susceptible to foreign tensions or in those that may benefit from war. For example, energy and military stocks could see a boon from the current climate, and in a properly diversified portfolio, their gains could offset some losses from negatively impacted investments.
Speak to Your Financial Advisor
This is the most important step. Your financial plan should account for all types of risk, including geopolitical risk. Speak with your financial advisor about the current geopolitical environment and how your portfolio could be impacted.
Mitigate Risk with Financial Fingerprint™ From Meld Financial
At Meld Financial, our experienced advisors take the current geopolitical climate and your personal tolerance for risk into consideration when crafting your portfolio. In addition, you can rest assured that your investments were chosen with your financial goals and risk tolerance in mind.
Our proprietary wealth management platform, Financial Fingerprint™, accounts for all types of risk in order to design a portfolio that meets your investing goals. And when your situation changes, so does your plan. That’s because Financial Fingerprint™ is quick to assemble, easy to understand, and simple to modify as your circumstances change.
When you work with Meld Financial, our team of tax, legal, and financial professionals will collaborate to ensure your plan is appropriate to achieve your financial goals. Contact us today to get started.