Geopolitics is dangerous because it cannot be quantified in any asset pricing mathematical model.
I will never forget the summer of 1998. I managed a global emerging markets equities trading book when the asset class went ballistic due to geopolitical risk. General Suharto’s dictatorship in Indonesia ended after 33 years as anti-Chinese pogroms swept Jakarta. South Korea, bankrupted by the Asian flu, was forced to beg the IMF for a (then) historic $57 billion emergency loan. India’s new BJP government tested a nuclear bomb in the Rajasthan desert and Pakistan retaliated with a nuclear test in the Baluchistan desert. The US imposed sanctions on both countries. Turkey threatened to invade Baathist Syria. Nigerian dictator Sani Abacha suddenly died amid a plunge in oil prices. Russia defaulted on its rouble sovereign debt. The world’s biggest quant hedge fund (LTCM) failed and triggered a Fed bailout.
Fast-forward to the fragile world of 2015, the world of Putin, Ukraine, Daesh, the Greek debt time bomb, the Chinese stock market bubble and the civil wars in Libya, Yemen, Sudan, Syria and Iraq. As Wall Street parties on, I see a planet in geopolitical pain, a global economy fissured by Great Power rivalries, epic leverage, the threat of deflation and currency wars. Something is dangerously wrong in a world where a handful of central bankers can ignite epic asset bubbles while financial markets are vulnerable to spasms of liquidity shocks, as we saw with the Wall Street flash crash, the taper tantrum, the oil/rouble shocks and the recent four sigma rise in German Bund yields.
Geopolitics is dangerous because it cannot be quantified in any asset pricing mathematical model. When Kiev’s Euromaidan protestors forced the president of Ukraine to flee his palace, Putin sent his Spetsnaz commandos to seize Crimea in Europe’s biggest land grab since Serbian aggression in Kosovo. This was the ultimate sell signal for Russian equities, debt and the rouble, all financial leprosy in 2014. Still, our stock pick Sberbank is up 50 per cent in 2015.
Yet geopolitics can also be the trigger for market rallies. The election of the pro-market, pro-reformist BJP in India made the Sensex/Nifty a no brainer buy and Indian equities were up 32 per cent in 2014. My catalyst to go “long India” came in the late summer of 2013, when RBI Governor Rajan restored confidence in the rupee after New Delhi slashed the current account deficit via taxes on gold imports. In Pakistan, the $6.7 billion IMF loan, the privatisation of Habib Bank, Saudi Arabian deposits in the State Bank of Pakistan’s reserves, the military’s successes in the anti-Taliban war in North Waziristan and $3 billion sovereign issuance in the sukuk/Eurobond market screamed “long Karachi” to me. In 2014, Pakistani equities were up 35 per cent.
Geopolitics was also a major factor in my bearishness on Turkey and Brazil. In Brazil, while Dilma Rousseff won the October election, the Petrobras corruption scandal and the crash in the world commodities markets doomed Brazilian shares and the real despite the highest real rates in the world. In Turkey, President Erdogan’s political interference with the Ankara central bank and the $200 billion consumer banking debt shock in a nation with the world’s highest current account deficit prompted me to recommend shorting Turkish banks in successive columns. Turkish banks have fallen 30 per cent in 2015. Ahmet Davutoglu could be the most unfortunate Turkish Grand Vizier since Kara Mustafa at the siege of Vienna if Fed rate hikes and an exodus of offshore hot money forces a global run on the Turkish lira. The recent Turkish election marks the twilight of the Erdogan era.
It is all too easy for a money manager to get geopolitical risk wrong but — hello — the CIA missed the fall of the Soviet Union, the overthrow of Shah of Iran from his Peacock Throne and the chaos of the Arab Spring.
Geopolitical risk increases uncertainty, erodes consumer confidence, capex and FDI, as is obvious in Putin’s Russia, post-Thaksin Thailand, Bolivarian Venezuela and Peronist Argentina. Sovereign risk is a critical variable in the hyper-volatile netherworld of the planet’s dark alleys, the money souks of the Third World now politely rebranded as emerging/frontier markets.
Researched and compiled by Matein Khalid. Mr Khalid is a global equities strategist and fund manager. He can be contacted at: matein@emirates.net.ae
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