Is it better to stand and fight or to turn and take flight? Should we now be fearful or should we be greedy? Is the return of our capital more important than return on our capital? It would seem that these are some of the questions that many investors might be asking more often now, given the heightened level of geopolitical risk. That is not entirely surprising following the spate of terrorist attacks that, at one time, were atrocities that appeared to happen only in faraway places. But these acts of barbarism are now something that could affect all of…
Is it better to stand and fight or to turn and take flight? Should we now be fearful or should we be greedy? Is the return of our capital more important than return on our capital?
It would seem that these are some of the questions that many investors might be asking more often now, given the heightened level of geopolitical risk. That is not entirely surprising following the spate of terrorist attacks that, at one time, were atrocities that appeared to happen only in faraway places.
But these acts of barbarism are now something that could affect all of us.
Given the threat of geopolitical risks, it is, perhaps, understandable to ask why market reaction has been muted, thus far. Have we somehow become immune to acts of savagery? When terrorists forced their way into the offices of the French satirical magazine, Charlie Hebdo, markets around the world barely budged.
When terrorists attacked Paris on the night of 13 November, some markets even inched higher the next day, almost as though nothing had happened.
The more things change…
The answer to the market’s somewhat unexpected response might be found in an old French proverb, which says that the more things change, the more they stay the same.
Markets, it seems, have a way of coping with risk, provided the risk can be adequately quantified. Terrorism, for instance, is something that markets have already factored into the price of stocks. We will never know where or when terrorists are likely to strike next, but we are aware of their clear and present danger.
Consequently, share prices already reflect the risks, to some degree. That is not to say that certain shares might not be affect in the short term, whenever there is a new and unquantified geopolitical risk.
When new geopolitical risks arise, markets could fall, that is until the risks can be properly assessed. However a brief and edgy reaction to the newfound risk is understandable.
But if the events are believed to be contained to specific regions or to particular sectors, then the falls could be both short-term and short-lived.
That is not to say that, as investors, we are not affected emotionally by these tragedies. We almost certainly are, but our analytical brain is also assessing the impact that the risks could have on economies at a macro level and businesses at the micro level.
Provided the risks are unlikely to affect economic activity on a wider scale, then they should neither have a lasting impact nor lead to protracted market reactions. In fact, it would take quite a lot to adversely affect global economic activity.
It is important to bear in mind that the US, the Eurozone, China, Japan and the UK together account for around two-thirds of global GDP. Terrorists are therefore misguided, if they believe that they can disrupt economic and market activity through their actions.
The key driver to stock prices, as always, will be based on the market’s ability to assess the impact of any risk on a company’s earnings and its revenues. These will be different for different industries.
In some cases, the impact could be minimal to almost non-existent. In other instances, it could be significant but, again, probably only in the short term.
For instance, companies that are linked to tourism could be temporarily affected by the recent terrorist attacks in Paris, as tourists from around the world reassess their travel plans. Consequently, airlines such as Singapore Airlines (SGX: C6L) and hotel operators such as GuocoLeisure (SGX: B16), which are at the forefront of the travel industry, could be some of the first to feel the impact.
Some tour operators or airport services companies, such as SATS (SGX: S58), might also be affected. However, some, if not most travel plans, could be postponed rather than cancelled outright. As a result, the impact on tourism might result in, at worst, one or two disappointing sets of quarterly results, if at all.
Banking on a rate rise
Banks could be disappointed if the European Central Bank should feel the need to provide more stimuli to the Eurozone economy through lower interest rates.
Whilst more monetary stimulus could benefit the wider economy, banks would prefer interest rates to go up, given that the bulk of their earnings are generated from the difference between the interest they can charge on borrowers and the interest they pay depositors.
Stock markets have a tendency to overreact to any new risks that emerge. But in times of heightened tension, rational investors should always ask how it might affect the performance of companies.
More often than not, there is only a small chance that isolated incidences could spiral into something that will adversely affect overall market returns, drastically. That could be in stark contrast to coverage in some sections the media. But as investors, we need to know the difference.
A version of this article first appeared in The Independent on Sunday.
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