Geopolitical Noise? Don’t Worry About It

September 01, 2017

This article is part of a regular series of thought leadership pieces from some of the more influential ETF strategists in the money management industry. Today’s article features Mark Eshman, chairman and chief investment officer of Sun Valley, Idaho-based ClearRock Capital.

The No. 1 question we’re fielding from clients these days is, “What do you think all this noise coming out of Washington, D.C. means for markets?”

Much has been written recently about geopolitics and financial markets. In the past month alone, we’ve read papers on these topics from hedge fund titan Ray Dalio, Societe Generale and UBS, to name a few. There’s plenty of noise.

We, too, have written quite often about the topic, always reaching the same conclusion: Short-term disruptions are nearly always brief and may provide good long-term buying opportunities. In other words, don’t worry about the noise.

Ultimately, what matters most to markets is whether or not corporate profits are growing, and that’s usually a function of where we are in the business cycle. Clearly, the general level of interest rates is reflective of this.

By way of example, let's take a look at what's transpired in just the past four weeks:


Geopolitical Noise Chart

For a larger view, please click on the image above.


Markets Barely React To North Korea

During those four weeks, the price of the SPDR S&P 500 Trust (SPY) moved from $247 to $248 and then to $246—a mere 4/10ths of 1% lower than the level before an escalated threat of a nuclear strike (per Bloomberg data). Why are markets shrugging off this potentially catastrophic global event? Why shouldn’t we convert our portfolios into cash (or gold) and wait for tensions to blow over?

The answer is fairly straightforward. First, North Korea has a checkered reputation for firing off incendiary rhetoric followed at some point by largely unsuccessful efforts to gain leverage from its adversaries. China can—and likely would—end this standoff quickly, as its economic support of North Korea is critical.

The Short-Term Nature Of Threats

Second, looking back at 80 years of data, a Charles Schwab study showed that, with few exceptions, geopolitical events actually don’t lead to market losses in both the short and long term. That’s because most of these conflicts tend to be small and brief.

We’ve seen this type of market behavior before. Consider the 1962 Cuban Missile Crisis and the 2003 Iraq War. During each of these ideological conflicts, weapons of mass destruction were involved, as were UN inspections.

The S&P 500 Index slid around 10% as geopolitical tensions rose over the first six weeks of each event. But nine months after the index’s low point in each of those event, the index had rallied more than 40%, far exceeding levels at the beginning of each conflict. 



As illustrated in the chart above, even if an investor had perfectly timed the initial sale of their portfolio and moved their assets to cash, they would have avoided the 10% drop, but the odds that they could have moved back into the market at the exact bottom and enjoyed the next 40% move up are slim. In other words, when it comes to timing markets, you have to be precisely correct twice!

History is full of uncertainty and market gyrations connected to each uncertainty. Making knee-jerk investment decisions based on emotions often results in disappointing performance. Staying the course is usually the best course.

As a firm, we believe “staying the course” means remaining broadly and globally diversified. We have four all-ETF model portfolios that do just that. We know that, over time, all asset classes rise, but because each is influenced by different factors, they do so at different rates.

You can hedge your allocation—with assets such as the SPDR Gold Trust (GLD)—to protect the portfolio against the type of short-term gyrations that could occur because of geopolitical turmoil. Diversification ultimately should reduce portfolio volatility.

But focusing on the noise, and making allocation decisions based on short-term events, is a fool’s errand.

Mark Eshman is co-founder and CIO of ClearRock, an SEC-registered investment advisor with offices in San Francisco and Sun Valley, Idaho. ClearRock clients currently own GLD. Contact: [email protected]. For a full list of disclosures, please click here.


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