By: Nick van Rensburg, Strategy Consultant at All Weather, managers of the Amplify SCI* Enhanced Equity Retail Hedge Fund.
I learnt from Warren Buffett that we should ignore geopolitics, and this advice worked well until early 2016. Since Brexit and Trump, this advice has become riskier, and even Mr Buffett is struggling with the adjustment.
He recently sold $4bn worth of Taiwan Semiconductor Manufacturing Company (TSMC) stock due to “political risk” but left his Apple stake intact. Apple, his largest holding by far, has about 25 times the Taiwan invasion risk as his TSMC holding, as Apple “manufactures” over 70% of its sales in China, with chips sourced from Taiwan. Even the best investors struggle with geopolitical risks in a more populist, multipolar world.
Markets have been blind-sided time and again by political and geopolitical events such as Brexit, Trump, Covid and the related shutdown of the global economy, the largest fiscal stimulus in history, the Chinese clampdown on technology stocks, Russia’s invasion of Ukraine, and the abrupt reopening of China post the end of Zero-Covid.
More recently, the Houthis in Yemen have disrupted trade flows through the Suez Canal, through which 25-30% of annual global container traffic transits. Their drone and missile attacks caused traffic through the canal to fall by 80%, and global shipping rates to increase by 70% year on year.
This is relevant to investors expecting an imminent rate-cutting cycle, as a fall in goods inflation has been the main driver of falling US CPI, while services inflation has been much stickier. A band of Houthis in Yemen could thus contribute to higher goods prices and potentially a slower rate-cutting cycle.
Additionally, oil has been elevated as global demand remains strong, while Ukraine is reducing Russian oil product exports by attacking large Russian oil refineries with drones. There is also a geopolitical risk premium in oil prices as tensions between Israel and Iran escalate. Iran produces around 4% of global oil, and around 21% of global oil transits through the narrow Strait of Hormuz, bordering Iran.
While food and energy are generally excluded by policymakers when assessing inflation, the indirect energy costs relating to the transport of goods are not excluded.
Another novel risk is that carry trades would unwind. For decades, Japanese investors have been borrowing in Japan at very low interest rates and investing in global bond markets to earn much higher yields not available in long-time deflationary Japan. The Bank of Japan is in the early phases of unwinding its ultra-low interest rate policy, and if it hikes fast, rather than slow, global carry trades could unwind, negatively affecting bonds in the US, EU, Australia, New Zealand, SA, Brazil, and India. For now, it seems more likely it will hike slowly. Japanese private investors own an estimated $4 trillion in mostly bonds of these countries.
The Russia-Ukraine war should see an inflection point within the next month as the US is likely to approve $60bn of additional funding for Ukraine, along with seizing approximately $60bn of already frozen Russian Central Bank assets and transferring it to Ukraine. Ukraine will thus go from currently underfunded to well-funded for its defense against Russia. An additional $120bn of Ukrainian funding should cause Putin to recalculate. Does he consider diplomacy, or escalation? Russian and Ukraine are large exporters of corn, wheat, sunflower oil, oil, natural gas, fertiliser, and palladium. The choice of response could affect goods, food, and energy prices.
The likely US seizure of Russian Central Bank assets would cause numerous global central banks to question the risk-free nature of US Treasuries. Treasuries are risk-free for friends, and very risky for future enemies.
It should be clear that geopolitics can affect inflation, and studies have shown that inflation affects election outcomes. It also affects interest rate policies, and it seems that a possible goods inflation resurgence could mean that US rate cuts might be slower than expected. Russia-Ukraine diplomacy seems a distant dream currently, yet I hope for diplomatic progress. War is inflationary, peace is disinflationary.
A multipolar world brings greater geopolitical uncertainty, and we need to be alert to its effects.
*Sanlam Collective Investments
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