Article / 10 July 2014 at 10:38 GMT

Geopolitical risk - does it matter?

Chief Economist & CIO / Saxo Bank
Denmark
  • Fundamentals prevail in the long run
  • Victory of micro narrative over macro
  • Tech, education and R&D attract cash

By Steen Jakobsen

Geopolitical risk has always been a “discount” on market valuations, how much so varies with the tensions around the world and more often than not particularly what goes on in the Middle East. The quick answer really is that geopolitical risk does not matter and should not matter…in the long term.

Fundamentals will always prevail in the long run. A company which is innovative, productive and cost conscious and has a positive cash flow will always attract capital and investors whatever country and region it's placed in and despite its political risk. I like to say it’s the victory of the individual story over the momentum-driven. It’s the strength of the micro story versus the macro story. 

pharma

Smart money will always follow smart businesses. Photo: Abid Katib

 I go to about 35 countries in an average year. Everywhere, and I mean everywhere, I meet smart, cool and incredibly successful companies and people – this includes Argentina, China, Brazil, Indonesia, Israel, Palestine, France and even Denmark! Everywhere you go you'll find investors and business people trying to succeed, opening the doors to their businesses every morning trying to make a dollar. 

Nanny-state shackles

This is exactly why we should never concede to political troubles, risk premiums or wars when investing. Countries, economies and societies are individuals. Strong individuals who succeed despite the odds. Today's modern society is more of a nanny state than a productive state. It’s more macro than micro, but that’s also why global growth remains low.

Simply put, from a market perspective, we have more to fear from the planned economy approach than from geopolitical risk. Not that geopolitical risk is unimportant, but it’s always present and more often than not it’s in regions which have a relatively small impact on investable stocks and money markets. The US and Europe still dominate world markets with more than 60 percent weight in the global index.

Geopolitical risk premiums and certainly those associated with the Middle East are most easily read through the WTI crude market. At present, the risk premium in crude is 10-15 US dollars. This varies over time but at a low trades at zero and at a high around 25-50 dollars.

 Israeli edge

The Israeli stock market with its investment grade and inclusion into MSCI with a weight of 0.4% is a natural part of most global investors portfolios. The tiny 0.4%, of course, could make many investors skip the allocation, but here the uniqueness of the Israeli stock market triumphs: Israel has the world's highest rate of PhDs per capita and the world's highest research and development ratio in companies. The education system is strong and favourable to innovation and technology. If anything, I would predict that Israel should take a larger role in most fund managers' stock selections in the future. Society and economics are willing to travel far to get access to this kind of set-up and technology.

In other words: Israel’s and the  Middle East's weakness is geopolitical risk, but it’s nothing new and it's relatively constant. The upside is the micro structure – the Israeli focus on technology, education and innovation.

Overall, to assess local geopolitical risk into investment risk, the straightforward approach is to find the stock markets' total allocation in the MSCI. In the case of Israel the weight is 0.4% - hardly something the global market will notice. Canada is 3.8%. Again, a crisis in Canada would be negative but less so than one in the US  which has a weight of 48.8%! The MSCI AWI global index covers 85% of all investable stocks or basically the “global markets”.  The 2014 H1 full report includes performance, weight and also biggest holdings. The fact that Apple, Exxon, Microsoft, Johnson & Johnson and GE are the biggest elements is no surprise at all.

MSCI

Source: MSCI.com
 

The conclusion is this: geopolitical risk is hard to quantify, it does not really matter long-term, but short-term it causes mispricing which in itself offers opportunities. Investing is about extracting illiquidity from the market and geopolitical events often offer a big discount of entry as long as the fundamental story remains valid. From a macro perspective I will maintain that we have bigger risk from this giant monetary experiment which the central banks and policymakers have initiated, as they believe in macro – the ability to smooth over the business cycle. I, on the other hand, believe in people, ideas and micro.

-- Edited by Clare MacCarthy

Steen Jakobsen is Saxo Bank's chief economist and CIO

Disclaimer

The Saxo Bank Group entities each provide execution-only service and access to Tradingfloor.com permitting a person to view and/or use content available on or via the website is not intended to and does not change or expand on this. Such access and use are at all times subject to (i) The Terms of Use; (ii) Full Disclaimer; (iii) The Risk Warning; (iv) the Rules of Engagement and (v) Notices applying to Tradingfloor.com and/or its content in addition (where relevant) to the terms governing the use of hyperlinks on the website of a member of the Saxo Bank Group by which access to Tradingfloor.com is gained. Such content is therefore provided as no more than information. In particular no advice is intended to be provided or to be relied on as provided nor endorsed by any Saxo Bank Group entity; nor is it to be construed as solicitation or an incentive provided to subscribe for or sell or purchase any financial instrument. All trading or investments you make must be pursuant to your own unprompted and informed self-directed decision. As such no Saxo Bank Group entity will have or be liable for any losses that you may sustain as a result of any investment decision made in reliance on information which is available on Tradingfloor.com or as a result of the use of the Tradingfloor.com. Orders given and trades effected are deemed intended to be given or effected for the account of the customer with the Saxo Bank Group entity operating in the jurisdiction in which the customer resides and/or with whom the customer opened and maintains his/her trading account. When trading through Tradingfloor.com your contracting Saxo Bank Group entity will be the counterparty to any trading entered into by you. Tradingfloor.com does not contain (and should not be construed as containing) financial, investment, tax or trading advice or advice of any sort offered, recommended or endorsed by Saxo Bank Group and should not be construed as a record of ourtrading prices, or as an offer, incentive or solicitation for the subscription, sale or purchase in any financial instrument. To the extent that any content is construed as investment research, you must note and accept that the content was not intended to and has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such, would be considered as a marketing communication under relevant laws. Please read our disclaimers:
- Notification on Non-Independent Invetment Research
- Full disclaimer

Check your inbox for a mail from us to fully activate your profile. No mail? Have us re-send your verification mail