Geopolitical risk and investing – the rules?
Geopolitical risk has always been a "discount" on market valuations, how much so varies with the tension around the world and of course more often than not particulary what goes on in the Middle East. The quick answer really is that geopolitical risk does and should not matter… long term.
Fundamentals will always prevail long-term. A company which is innovative, productive, cost conscious, and with a positive cash flow will always attract capital and investors whatever country and region its 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- vs. the macro story. I go to about 35 countries in an average year. Everywhere, and I mean everywhere, I meet smart, cool and incredible successful companies and people – this includes Argentina, China, Brazil, Indonesia, Israel, Palenstine, France, and even Denmark J. Everywhere there is investors and business people trying to succeed, opening door to their business every morning trying to make a dollar.
This is exactly why we should never concede to political troubles, risk premia's or wars when investing. Countries, economies, and societies are individuals. Strong individuals who succeed despite the odds. Today modern society is more of a "nursing 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 not important, but it's always present and more often than not it's in regions which have a relatively small impact on the investable stocks and money markets. The US and Europe still dominate world markets with more than 60% weight in global index'.
Geopolitical risk premiums and certainly those associated with Middle East is most easily read through the WTI crude market. Presently the risk premium in Crude is 10-15 US dollar. This varies over time but at a low of course trades at zero and at high around 25-50 US dollar.
The Israeli stock market with its investor grade and inclusion into MSCI with a weight of 0.4% is natural part of most global investors portfolio's. The tiny 0.4% of course could make many investors skip the allocation, but here the uniqueness of the Israeli stock market comes triumph: Israel has the highest PhD per capita and the highest research and development ratio in companies and a society which everything being equal is homogenous and industrial. The educational system is strong and favorable to innovation and technology. If anything I would predict that Israel would take a larger role in most fund managers stock selection going forward due to this. Society and economics is willing to go a long distance to get access to this kind of set up and technology.
In other words: Israel's and Middle East weakness is the geopolitical risk, but it's nothing new and relatively constant. The upside is the micro structure – the Israeli focus on technology, education and innovation.
Overall to asses local geopolitical risk into investment risk- the straight forward approach is to find the stock markets total allocation in the MSCI. In the case of Israel the weight is 0.4% - hardly something global market will notice. Canada is 3.8% - Again a crisis in Canada would be negative but less so than in the US - US have 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 can be seen here including performance, weight and also biggest holdings. I am sure knowing that APPLE, Exxon, Microsoft, Johnson & Johnson and GE is the biggest holding will not come as major surprise!
Source: MSCI.com
The conclusion is this: geopolitical risk is hard to quantify, it's does not really matter long-term, but short term is creates mispricing which in itself offers opportunities. Investing is about extracting illiquidity from the market and geopolitical events often offers a big discount of entry as long as the fundamental story remains valid. From macro perspective I will maintain that we have bigger risk from this giant monetary experiment which the central banks and policy makers have initiated, as they believe in macro – the ability to smooth over business cycle, I, on the other hand believe in people, ideas and micro.
Safe travels,
Steen Jakobsen
Med venlig hilsen | Best regards
Steen Jakobsen | Chief Investment Officer
Saxo Bank A/S | Philip Heymans Allé 15 | DK-2900 Hellerup
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