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Global political instability: a threat to the markets? A macro view of volatility and market resilience

The Macro View

Chess pieces on a chessboard

The old stock exchange cliché goes “markets go up like an escalator, go down like an unhinged elevator”. The world learnt this lesson the hard way as geopolitical tensions between the US and North Korea escalated to nuclear brinkmanship. Trump’s ‘fire and fury’ bombast and Kim Jong-un’s threat to order a missile attack on Guam unnerved Wall Street/global equities and triggered safe haven flows into gold, the Japanese yen, Swiss franc and US Treasury notes. While the financial markets are not exactly priced for nuclear Armageddon, the Volatility Index has surged from 10 to 17 in a mere week and the S&P index tanked the most in a single session on 10 August since 17 May. After a 20% rally since the November election, US equities now face the very real prospect of profit taking amid a spasm global risk aversion.

While President Trump issued fresh warnings to North Korea, the Pentagon and Secretary of State Tillerson reassured the American people that war was not imminent. However, the spike in the Volatility Index means a geopolitical risk premium will now be incorporated into global equities, notably in high beta sectors such as technology, banking and the Asian stock markets – South Korea, Taiwan, Hong Kong, China and Japan. It is also significant that the S&P 500 index closed Friday at 2441, well below its 50 day moving average at 2448. The June/July summer grind higher is now unquestionably over.

Jeff Gundlach’s prediction that Wall Street will see a 3-5% correction while the Volatility Index will move from 10 to 20 makes strategic sense. Trump’s unpredictable nature and reckless rhetoric has amplified geopolitical risk but the financial markets do not price in the risk of a war that can be catastrophe for not only the Kim dynastic dictatorship in Pyongyang but also for South Korea, Japan and the global economy. The bull market survived the terrorist outrages in Europe, the Syrian civil war, Ukraine and the Russian invasion of Crimea. It will survive the latest spat with North Korea, especially if China enforces the embargo and forces the Kim regime to restrain its nuclear threats.

The SPX had spent 58 trading days without a 1% up or 1% down day even as US equities were overpriced at 19 times earnings, though EPS growth in the index can well be in the 11-12% range.

Apart from North Korea, global equities face risk events as diverse as Russiagate, the worsening relations between the Trump White House and the Republican Senate, minimal prospects for tax reforms and a German election that will be a referendum on Chancellor Angela Merkel’s pro-Europe, pro-refugee policies. This means political risk will be a sword of Damocles on US equities this autumn. Yet Fed policy, earnings growth and credit spreads tell me that the optimum strategy is still ‘buy on dips’. This will be a 5% hit to the US indices – the German DAX is down 7% from its peak, not a panic driven bear market.

The Macro View

About Matein Khalid

Matein Khalid

Matein Khalid is Chief Investment Officer of Asas Capital in the DIFC; he is responsible for global investment strategy and the development of the multi family office platform. He has worked in Wall Street money centre banks, securities firms and hedge funds in New York, London, Chicago and Geneva. In addition, he has been an advisor for royal investment offices in the Gulf for 8 years. Mr Khalid has four degrees in finance, economics, banking and international relations from the Wharton School, University of Pennsylvania. He is a director at the American College of Dubai and has taught MBA level courses in commercial/investment banking at the American University of Sharjah and British University of Dubai. He writes the Global Investing columns for Khaleej Times, Gulf Business and Oman Economic Review.

Articles by Matein Khalid

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