Article / 10 July 2014 at 10:38 GMT

Geopolitical risk - does it matter?

Chief Economist & CIO / Saxo Bank
  • 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. 


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.



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


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