Dealing with geopolitical threats

Traders need to be braced for margin calls and sudden bouts of abnormal volatility

The last two trading sessions have been dominated by speculation about Brexit. How will the new Brexit deal work for businesses and will it be ratified by parliamentary vote in the UK? Traders are betting heavily on both sides of that debate. Any corporate with UK/Euro exposure will be waiting for clarity, with bated breath.

Before the Brexit deal, it was the Syria-Turkey-Kurd triangle sparked off by the US military’s withdrawal from that theatre. There’s also the China-US tariff war, which may or may not, be nearing some form of resolution.

All this has overshadowed the dry dissection of corporate results as July-September 2019 quarterly numbers are announced. So far, the numbers have been less than stellar for Indian firms. Even firms in export-oriented sectors such as IT have flagged apprehensions of slow growth due to low global demand. 

Geopolitics is one of those things that value investors can try and ignore with a bottom-up approach. However, traders have to stay abreast of developments in this area since it can cause huge volatility in financial markets.

Analysing the long-term impact of geopolitical developments is hard. Predicting these, except in the form of known-unknowns and unknown-unknowns, is near-impossible. Take the Middle East situation. There are multiple potential flashpoints.

Iran and Saudi Arabia are fighting a proxy war in Yemen. The US pulling out of Syria has emboldened Turkey to strike across the border at Kurdish forces. There have been terrorist strikes on a Saudi refinery and on an Iranian tanker. All sorts of things could happen and any of those would have some impact on crude and gas prices. There could be an escalation of hostilities in any of these flashpoints.  It’s impossible to predict what will occur but traders can build scenarios to assess where energy markets will go.

In a less dramatic way, the US-China tariff war could go in many directions. The US and China may roll back tariffs to more restricted lists. In the best-case scenario, they could switch back to the situation before the tariff war was triggered. In the worst-case scenarios, both nations may impose higher tariffs on larger lists.  

The tariff war has already led to a fall in global GDP growth rates. It has triggered a long-term bear market in industrial metals, energy and other commodities. Every time there is news, the markets will see a knee-jerk reaction.

The Brexit situation is also hard to analyse sensibly. The current deal being offered doesn’t seem to change the situation much compared to the previous one, which was rejected by the UK Parliament. However, there was a relief rally merely on hopes that the deal would go through. There could be a crash if there is a rejection. If there’s a new referendum, however, the market will have to factor even more bewildering sets of outcomes.

One problem with the geopolitical situations mentioned above is that the negative impact on growth cannot be tackled by normal means. In the Subprime crisis of 2008, and the follow-on financial crisis of 2011-12, the world’s central banks could take centre stage to carry out a rescue. The central banks pushed out a flood of cheap money and eventually that led to a growth resurgence.

Unlike in 2008, there is no leeway to cut rates by a great deal, or to deploy quantitative easing on the same scale. Nor would central bank action help all that much. This particular growth recession has been triggered by geopolitical developments and it will have to be resolved, or contained, by geopolitical negotiations.

What should investors and traders do to cope with such possibilities? A long-term equity investor cannot ignore these situations absolutely because there will be an impact even on businesses that don’t have direct exposure. People with long-term portfolios can try to ride out the turbulence by looking at perspectives of three years, or longer. This means not parking savings that may need to be tapped at any stage earlier than late 2021. 

Short-term traders need to be braced for massive margin calls and sudden bouts of abnormal volatility. Anybody with currency markets or commodity exposures must assume that the trends there could alter suddenly and violently. This sort of volatility is obviously a chance to get rich quick.  It is also a chance to go bankrupt even quicker!