The Three Questions Investors Should Ask In The Middle Of A Geopolitical Shock by Colin Moore, Columbia Threadneedle Investments

Originally published on FE TRUSTNET on October 06, 2015 and authored by Gary Jackson, Editor.

Columbia Threadneedle’s global CIO reveals the three questions he asks when deciding how to react to a geopolitical crisis and which risk is concerning him the most right now.

Russia’s growing involvement in the Syrian conflict has raised a new risk for investors to include in their decision-making process, but Columbia Threadneedle’s Colin Moore says there are three questions investors need to ask when weighing up how to respond to a geopolitical event.

Recent years have been marked by a number of geopolitical worries that spilled over and affected markets, with examples including Russia’s annexation of Crimea and intervention in Ukraine, the rise of ISIS in Syria and Iraq, China’s dispute with Japan over the Senkaku Islands and the Greek debt crisis.

Exhibit 1 shows that returns from different parts of the globe have been mixed since the start of 2014 but illustrates that investors have generally been in for a rocky ride, owing to geopolitics, high valuations and worries about the timing of interest rate hikes.

Exhibit 1

Geopolitical Shock

A more recent issue to emerge is Russia’s decision to launch airstrikes on Syrian anti-government insurgents, which has led to allegations that the country is supporting Syrian president Bashar al-Assad. Furthermore, Turkey has claimed that Russian jets have entered its airspace while the U.S. has alleged the country is building up its ground forces in the area.

Moore, the global chief investment officer for Columbia Threadneedle Investments, is cognizant that geopolitical events can have a significant effect on markets but points out that they can sometimes be catalysts to buy rather than sell.

He likens geopolitical events to a pebble being dropped in water — the effect is most pronounced at the point of impact but gradually fades as the ripple pushes outwards.

“At the center of an event you tend to get an enormous impact on your market, but unless certain other factors come into play the dissipation rate is very fast — the ripple just fades away with time and distance,” he said.

An example of this would be the recent Greek debt crisis, he adds. The Greek stock market fell the most because of the crisis, with indices in southern Europe, the wider eurozone, the UK and the U.S. dropping by smaller magnitudes.

The decision on whether to pull money out of the market, hopefully before other investors, or invest during a geopolitical crisis depends on if the event’s ripple is likely to build on itself to create a “tsunami” or fade away quickly, he adds.

Moore says there are three questions investors need to ask themselves in the midst of geopolitical event. An answer of “yes” to any one means that there is a strong potential for things to get worse rather than better in the short term.

Is a superpower involved?

“The first is the involvement of a superpower or a country that could be a superpower and has the ability to project that power. They can take a local issue and make it a global one,” the CIO said.

“Russia is one of the countries we think is looking to return to being a superpower — it’s a “superpower wannabe” — and it is the creation or dilution of superpower that tends to lead to periods of instability.”

Moore was speaking before launched airstrikes in Syria, but he highlighted Russia’s seeming aspirations to regain superpower status as the geopolitical risk that concerns him the most.

Exhibit 2

Geopolitical Shock

In order to be regarded as a superpower, a nation has to be able to project its power across the globe and the most conventional means of doing this is through building a strong navy. Moore argues that this was part of the reason behind Russia’s move to annex Crimea.

“One of the reasons they were interested in Crimea is because it’s one of the few warm water ports they have open to them; if you want to project your power, you need to able to operate your navy at all times,” he said.

“The assertion of being macho and strong leads to the potential for very risky behaviour that could take the market by surprise. And because it is coming from a superpower wannabe, it has the power to escalate. Anything that involves Russia is my biggest fear.”

Is the global oil supply involved?

Moore continued, “The second is a threat to the world oil supply; not so much gas, as gas is a regional commodity. Russia supplies western Europe with gas, so it makes it a super-regional thing, but it’s not really a global thing.”

He pointed out that while the humanitarian cost of the instability in Libya has been “terrible,” the market has shown little concern as the country is responsible for less than 2% of global oil supply.

However, when instability is seen in the Middle East — which produces far more of the world’s oil — the market impact is much more apparent. Of course, this is a risk that is heightened by the presence of a potential superpower in the Syrian conflict.

“You take that potential for instability to an area that is responsible for closer to 20% of the world’s oil supply and everybody can get really worried about it,” he warned.

Exhibit 3

Geopolitical Shock

Is there a threat to the global banking system?

“The third one is a threat to the global banking system,” Moore said. “That’s relatively new so there’s less research to prove that a threat to the banking system makes geopolitical events more impactful, but it’s at least intuitive that this would be a way to make a crisis global.”

In the run-up to the global financial crisis of 2008/09, the end result of mass defaults in the U.S. subprime mortgage market was the collapse or near-collapse of several major banks, a spike in public debt in many countries and a global recession which is still being dealt with today.

“A bad mortgage situation in the U.S. causes a crisis in Iceland and then a European bank has to take a massive charge. Banking is a transmission mechanism; so is a navy, and if you think about oil, it’s what we all use to move around and it’s shipped across the world,” the CIO said.

Exhibit 4

Geopolitical Shock

Moore concluded, “When I look at a crisis and ask if I’m going to sell or buy, I want to know if it’s going to build on itself or if it’s going to dissipate.”

“The initial reaction of people is always panic so the second thing they should be thinking is, Shall I take advantage of that or should I try to get ahead of it? The three tests are: Is there a superpower involved?, Is oil involved?, and Is there a threat to the banking system? If not, then I know it’s an opportunity.”

Gary Jackson was recently a guest of Columbia Threadneedle on a media trip to the United States.