Arguably the two most influential people in the world skipped it — Xi Jinping and Donald Trump wouldn’t dare risk their dos in a beanie. Their absence didn’t stop Davos’s huffers in puffers talking geopolitics all week though.
This year’s World Economic Forum had four themes. But “achieving security and co-operation in a fractured world” and artificial intelligence dominated the agenda. Jobs and growth and the compulsory climate stuff were sideshows.
I’m going to write about AI soon. For now, Gaza, Ukraine, the Red Sea and Taiwan hog the headlines. Sabres are rattling everywhere. On Monday, Grant Shapps, UK defence secretary, said: “We’ve come full circle, moving from a postwar to a prewar world.” Yikes!
Everyone says I should care. Not as a human being — I’ve got four young kids for goodness sakes — but as an investor. I’m forever being told in meetings these days “we’re all geopolitics experts now”. Nothing else matters.
This troubles me for two reasons. First, investment professionals are terrible ultracrepidarians. What does a Wall Street broker know about Yemeni troop movements? Or your favourite credit analyst about China’s ambitions in the Pacific?
And heaven forbid if geopolitics is the only game in town. If you think inflation data or valuing US stocks are hard to fathom (a recent note by in the FT’s Unhedged newsletter is a good place to start) try war-gaming the Middle East.
Luckily, the influence of geopolitics is exaggerated — the second reason obsessing about it vexes me. Particularly on equities. The truth is that stocks can handle most conflicts, despite us being told how much they hate uncertainty.
Take average annualised US stock returns during four wars: the second world war, Korea, Vietnam and the Gulf war (we’ll exclude Iraq as it coincided with a big and unrelated recession). Gains were bigger during these wars than the long-run mean, for both large and small-caps.
Indeed, US equities rose double digits on average during the 10 military actions the nation has been involved in going back to the Spanish-American War of 1898 — rising in absolute terms in seven of them. During the second world war, the S&P 500 grew by half.
More amazing, a CFA Institute analysis found that US stocks were less volatile during times of war too. That’s impressive considering shares tend to be badly spooked in the early weeks of a conflict (or a potential one).
CFRA Research examined almost two dozen reported attacks, from Pearl Harbor and the opening shots of the Yom Kippur war to September 11 2001 and the London Underground bombing of 2005. On average, the S&P 500 immediately fell 1.2 per cent.
It then drops another 5 per cent over the next three weeks. But 47 days later, on average, US stocks recover their losses and go on to greater things. Keep your head down and don’t sell is the lesson. Unless your uncle at the Pentagon tips you off.
Of course it helps that the US is usually thousands of miles from the gunfire. Nearer home, many European markets closed and reopened more than once during the second world war. Russian equities fell 27 per cent in the year after Ukraine was invaded.
Despite a threat of invasion, however, UK stocks performed better between 1939 and 1945 than the preceding five years, the following seven years, as well as the long-run average, notes a paper by academics Robert Hudson and Andrew Urquhart. Russian equities are now above where they were in February 2022.
But while equities can ignore, say, that Beijing’s shipbuilding capacity is 230 times greater than that of the US, fixed income cannot. Government bond and credit markets aren’t designed to enjoy war, either due to rampant supply to raise funds, trading controls, or because of inflation. Sometimes all three.
Even in the distant US, holders of sovereign and corporate bonds earned less than half the usual long-run returns during periods of war, on average. That said, no threats big or small have scared the bull market in fixed income since 1981.
Where does all this leave my portfolio? Given the title of this column, I believe conflicts are becoming ever more likely as technological advances in weapons such as missiles and drones leave combatants and their commanders with less skin in the game.
So I must be wary. My equities, as explained above, can look after themselves. What is more, if investors panic for any geopolitical reason, I’d rather be holding cheap stocks than expensive ones — another reason to own Asia, Japan and UK funds, therefore.
Meanwhile you’d reckon that supply shocks, such the Houthi attacks on shipping lanes, would be helping my energy bet. However no causal relationship exists between geopolitics and oil prices, as research by the universities of Navarra and Francisco de Vitoria shows. Any price moves are shortlived at best.
In fact, my energy ETF is heading south at the moment, due to worries about economic growth — especially China’s. But I bought it as an inflation hedge, which only means I’m miffed that stronger-than-expected consumer price figures out of the US and UK recently haven’t helped.
This leaves my US government, short-dated bond fund. It normally wouldn’t enjoy the higher inflation number for December, but its sterling returns are being saved by the strong run in the dollar since January.
Action points, then? If stocks tumble this year, for whatever geopolitical idiocy, I’ll jump in and buy, much as I did in the first quarter of 2020 as investors fled to their basements to escape Covid, swapping equities for loo roll.
And I’ll fund those purchases by selling my bond ETF. I’d expect that to leap initially as treasuries are considered haven assets. But they wouldn’t be if things became ugly.
The author is a former portfolio manager. Email: stuart.kirk@ft.com; Twitter: @stuartkirk__
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