Investors -- in fact, anyone -- can be forgiven for getting a headache while hearing or watching news and the parade of geopolitical crises.
As I write this column, bombings are rocking Kabul, Afghanistan’s capital, North Korea has fired new short-range ballistic missiles, the BREXIT fiasco remains unresolved in the United Kingdom, protests continue in Hong Kong, the tensions in the Middle East seem to imply the possibility of war, and the trade dispute continues between the United States and China.
And that’s just the major headlines.
We know that having a truly comprehensive investment portfolio means investing outside the country. However, that brings with it the challenge of identifying which geopolitical crises have the greatest potential for impact, or even whether any impact should be expected.Currently, given the realities in the Middle East, and trade issues between China and the United States, investors need to factor those tensions into their decisions, according to Jay Nash, Senior Vice-President, Portfolio Manager and Investment Advisor at the London branch of National Bank and a 21-year veteran of the financial sector.Still -- and perhaps surprisingly, -- although the markets may seem overly unstable now, current volatility is below historical averages, Nash says, adding that the summer months are generally less volatile. At time of writing, the S&P/TSX Composite is currently at 14.4 times earnings versus a long-term mean level of about 15 times. The S&P 500 is currently showing 17.2 times forward P/E versus a long-term mean of about 16.5 times.
This can lead to examining a portfolio from three different perspectives: Asset allocation: referring to total exposure of equities; Top down: referring to macro considerations such as Middle East tensions; and Bottom up: referring to individual securities
However, this does not necessarily mean that changes to a portfolio have become appropriate and some seeming solutions to the impact of these crises may not be necessary.The volatility caused by geopolitical events might lead some to seek the comparative shelter of fixed income investments. Generally, however, investors should keep their established asset allocation in place, Nash suggests. Keeping the long-term balance in view will always be important despite short-term developments. At the same time, some crises may lead to underpriced equities that present buying opportunities, as is the case currently in the British stock market.Also, preferred shares, sometimes seen as a haven from market volatility, may not provide a workable solution since they have performed poorly over the past three years, Nash says. The challenges here include low liquidity, even for top-quality shares.Alternative asset classes may or may not become appropriate. In times of volatility, diversification of asset classes may be a solution, depending on other factors in the investor’s situation. However, investors need to recognize the potential long-term impact of holding assets such as gold and silver. These assets may outperform equities during negatives times, but they can also be a drag on portfolio performance over the long term.Investors must always be looking forward, but that is a tall order in the current climate. At time of writing, some analysts see war in the Gulf Region as inevitable, while others strongly discount the possibility. When the outcome of a crisis is near impossible to predict, the impact on investments becomes even more difficult to forecast.Those who feared the outcome of the BREXIT vote and reduced equities were correct for only three days following the vote, Nash recalls. Those who feared a Trump election and took action were wrong by the time North American markets opened the next morning.The American political scene is likely to impact the market many times between now and the election next year, with each party making their case for leadership. American equity markets are not cheap on a historical basis today, so investors should approach November 2020 with some caution, Nash says.An investor who becomes unduly worried about the impact of these events may, in fact, need to revisit his or her risk tolerance. The nervousness may mean that their portfolios are not completely aligned with their real risk tolerance.This equation requires that an investor crystallizes his or her own beliefs. If an investor believes that capitalism will continue and that inflation will persist, the need to maintain significant holdings in non-correlated assets is low, Nash believes. By comparison, if an investor believes that either of these forces will change substantially, he or she may find some comfort and re-assurance from investing outside of the conventional stock market.Related: The Elections and Your Portfolio