#70 Geopolitical Uncertainties and how markets react

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#70 Geopolitical Uncertainties and how markets react

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Geopolitical Uncertainties and how markets react

Goldman Sachs Asset Management

Crisis Lessons: Stay Invested, Stay Active

Market behavior can be extremely unpredictable at the best of times, and timing market moves is difficult even for seasoned investors. It’s even more challenging in a crisis environment. We looked at how equities performed during and shortly after periods of elevated geopolitical risk. While stocks have shown an ability to recover fairly quickly after a crisis ends, predicting when the end would have come would have been challenging.

It was equally difficult to predict market behavior when the Covid-19 pandemic began. Investors who reduced exposure to stocks and other risk assets, such as corporate credit, in March 2020 to take refuge in safe-haven investments would have missed the rapid financial market rebound that followed. On the other hand, it would have taken investors who did nothing to their portfolios when the global financial crisis erupted several years to recover their losses. If nothing else, this should serve as a reminder to approach portfolio decision-making during disruptive events and heightened market volatility with a healthy dose of humility.

The first thing that those with the luxury of long investment horizons should consider, in our view, is a simple one: stay invested and focus on the big picture. For example, equity performance can be highly unpredictable over the short term. As Exhibit 2 illustrates, the S&P 500 delivered positive returns on a daily basis just 54% of the time between 1969 and 2021—not much better than a coin flip. Extend the holding period to three years or more and it’s a very different story.

Central Bankers’ Dilemma

Higher commodity prices will complicate the Federal Reserve’s goal of dragging inflation back down to its 2% target over the next 12 to 18 months. If prices remain higher for longer, Fed policy makers can be more inclined to hike rates rapidly and substantially to keep inflation expectations in check. But if they raise rates by too much, they risk starting a recession. On the other hand, looser monetary policy in the face of today’s inflationary challenges could lead to stagflation. Hitting that 2% target while also maintaining positive, at-trend growth, will be difficult. The room for unintended consequences and a potential policy error have increased substantially since the Ukraine invasion.

Economic Growth and Investment Strategy

In light of these challenges, we have downgraded our outlook for growth in 2022 and 2023, particularly in Europe. New sanctions-induced supply chain disruptions and spikes in commodity prices are likely to create major regional and country-specific economic disparities that lead to differences in the rates of growth and inflation. At the top of the list is Europe, considering its reliance on Russia for energy and other commodities.

We expect that high energy bills—which may remain high even when the fighting stops—will reduce household purchasing power and suppress discretionary consumption. Consumers may also choose to reduce energy consumption in favor of other goods and services. This may discourage capital expenditure at traditional fossil fuel energy firms, and lower capital expenditures on downstream corporations and end-consumer spending may dampen growth for prolonged periods of time.

Triodos Investment Management

Trust in the right capital allocation

Investors monitor financial markets to make informed investment decisions. Their views and choices are often seen as a gauge of the health of an economy. However, there is an increasing disconnect between real economic developments and the search for financial returns. Trust in investors’ views on capital allocation is now being challenged. According to the IMF abundant liquidity is leading to equity price misalignments (relative to fundamentals-based values), which remain elevated in most markets.

In the larger emerging economies, including India, where equity market performance has been less overwhelming than in advanced economies, performance has also been considerably strong, while credit remains scarce, and inequality has been increasing. The consequence is that the gap between those benefitting from wealth creation and those that have no savings is increasing. One of the claims is that stimulus has supported financial markets and that it has been unable to revive real activity and reduce inequality. Here the lack of trust in markets making the right capital allocations is expanding to the distrust in institutions and how they facilitate this allocation, including central banks’ accountability.

Global Market Outlook

Earnings Growth to Boost Equities Despite Market Volatility

Powered by unprecedented monetary and fiscal support, equities markets performed strongly in 2021. The coming year presents a complex picture as the global economy finds itself on an uncertain climb toward recovery. Monetary intervention is dwindling as inflation proves to be stickier than originally hoped; bond yields could surprise to the upside. Increased volatility is also looming, as equities markets rise and fall in response to the ebb and flow of the global pandemic, and in response to policy signaling.

We continue to favor equities compared with other asset classes, because they still offer relatively attractive excess returns. The equity risk premium (ERP) for developed markets, for example, stands at 4.8% as of September 1, 2021. This represents a drop compared with the same time last year; however, the ERP remains positive and, as of this writing, remains above long-term averages in both developed and emerging markets.

In a welcome change from prior years, earnings, not multiples, have driven equity performance so far in 2021. With risk to bond yields falling to the upside, earnings must continue to come through for equities markets to continue to rally further.

Volatility is making a comeback

Aggregate levels of volatility have settled in at a higher level in 2021 than we’ve experienced in recent years; caution is warranted heading into 2022. In particular, we think investors may benefit from seeking pockets of the equities market where reasonable valuations can give more of a cushion against volatility.

Cyclical stocks will benefit from hard infrastructure spending

A wave of infrastructure spending, exemplified by the recent passage of a $1 trillion infrastructure bill in the US, will benefit cyclical sectors including industrial, materials, energy, and financial firms. Indeed, a substantial portion of our confidence in continued earnings strength is based on our expectation that cyclical stocks will benefit from renewed government emphasis on hard infrastructure. These latest moves build on existing trends to further benefit cyclical stocks; industrials reported the strongest earnings in the most recent earnings season, while a gradual steepening of the yield curve has benefited financials. Note, too, that an upward trend for cyclical stocks is likely to benefit European equity markets, which skew toward cyclicals.

My conclusions and considerations

  • Is very useful to see and to study how after 3 months during geopolitical crises the equity market performance rebound, from S&P 500 to EMs.
  • Staying invested can offer a higher return potential.
  • The harder thing in my view in these situations is to manage the own emotions and patient. A lot of study it necessary to have for managing at the best the harder situations on the markets.
  • In this article we have represented a few of them based on numbers and facts.
  1. Stay invested and focus on the big picture.
  2. Equity performance can be highly unpredictable over the short term.
  3. The coming year presents a complex picture as the global economy finds itself on an uncertain climb toward recovery.
  4. Cyclical stocks will benefit from hard infrastructure spending.

Join the conversation with your own take on these topics in the comments below.

About the Author

Alessandro is a Financial Markets enthusiastic and he loves learning from articles/papers on many financial topics and in doing so he shares with you the most interesting charts and comments.


This material is not intended as an offer or solicitation for the purchase or sale of any financial instrument. This material has been prepared for informational purposes only. Any forecasts contained herein are for illustrative purposes only and are not to be relied upon as advice or interpreted as a recommendation.

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