Geopolitical risk captures a wide range of issues, from global trade tensions, military conflicts to regional tensions such as Brexit and European fragmentation. Geopolitical concerns were key catalysts for financial market returns during 2019 and remain the overarching story as we kick-start 2020.
The new year started with heightened geopolitical risk in the Middle East as US President Donald Trump announced the assassination of the head of Iranian Revolutionary Guards’ overseas forces, Qassem Soleimani. This came as a measure to head off an imminent threat.
Less than a week later, Iran retaliated by firing 22 ballistic missiles at two Iraqi military basis which were hosting US-led coalition personnel.
Following strong financial market returns in 2019 across most asset classes, news of the US-Iran tensions has led to a temporary reassessment of short-term risks. The Middle East currently produces about a third of the world’s oil with, Saudi Arabia, Iran and Iraq topping the list of oil-producing nations. This means that any flare-up in tensions throughout the region raises concerns over the possible disruptions in oil supply.
As witnessed over the past days, the US-Iran tensions have pushed the price of oil higher, with the price of Brent crude exceeding at times the $70 a barrel. While the higher oil price levels negatively impacts airline companies, which have to factor in higher fuel costs, the elevated oil prices benefits energy stocks. Geopolitical risks also tend to create a risk-off environment, as investors shift away from riskier asset classes and regions to invest in safer assets. However, despite that equity indices have retreated from record highs, equity market reaction during the past few days has been fairly muted so far. Similarly to all situations which weigh down on market sentiment, the value of safe haven assets tends to increase as investors demand a hedge for their investments.
A safe haven asset is expected to gain in value during periods of market volatility and are therefore seen as a way to limit investment losses. Gold, the Japanese yen and government bonds are all considered safe haven assets. As expected, the price of gold has traded higher over the past week, hitting its highest level since April 2013 last Monday.
While the tensions have somewhat escalated over the past days, markets have so far focused on what is being signalled: that no one wants war, and as a result, the impact on the middle east tensions on financial markets has so far been limited. Despite that no one can really anticipate how the US-Iran tensions will evolve, the general consensus view is that major escalation is unlikely. However, until earnings season comes round, investors are likely to remain cautious on investing new capital, which increases the likelihood that financial markets remain more range bound.
Disclaimer: This article was issued by Rachel Meilak, CFA equity analyst at Calamatta Cuschieri. For more information visit www.cc.com.mt. The information, view and opinions provided in this article are being provided solely for educational and informational purposes and should not be construed as investment advice, advice concerning particular investments or investment decisions, or tax or legal advice.