Political risks to the market on the rise

Of the myriad risks listed on the average fund prospectus — market risk, interest rate risk, opportunity risk, to name just a few — political risk is one investors should start paying more attention to when selecting international investments.

“Politics increasingly matters to the markets,” says Ian Bremmer, president of political risk consultancy firm Eurasia Group. “If you look at the world for the past 20 years, you’d be forgiven for recognizing that hasn’t been the case.”

Speaking at the Toronto CFA Society’s 50th Forecast Dinner, Bremmer pointed out that over the past 20 years, the driver of markets has been the globalization of the supply chain. In the coming two decades, however, political stability, or the lack thereof, will become a stronger influence.

Political concerns, and not economics, are what drive anti-immigrant sentiment in Europe, protectionism in the U.S., jihadist car bombings and the development of nuclear weapons by rogue states.

The effects of these developments are clearly visible on the markets, most obviously influencing the prices of oil and gold, but these commodities have a huge impact on the global economy.

“All of this is happening in a world where the United States is no longer the dominant player, and is increasingly not feeling like the dominant player,” Bremmer says. “It’s not like there is one global challenger; there’s a whole bunch of regional challengers. The ability and willingness of the U.S. to do the lifting is increasingly challenged everywhere.”

With an American presidential election just over a year away, Bremmer says that which party wins is becoming less relevant. With either outcome, he expects the U.S. to be increasingly protectionist in reaction to its decreasing influence on world events.

With “neo-isolationism” becoming a real risk in the U.S., investors will need to understand the political workings of the rest of the world.

“We all know how exciting the emerging markets, and now the frontier markets, are. That’s where we’re getting alpha — it’s not the United States,” Bremmer says. “It’s China, it’s Brazil, Turkey, Vietnam, Cambodia and Kenya — all of these countries which aren’t particularly politically stable. If you want to understand the economic outcomes in these countries, you’d better understand how they work politically.”

As an example, he points to China. For the past couple of years, there has been a string of predictions that Chinese economic growth could not continue at its breakneck speed. But this overlooks the fact that the Chinese economic expansion is not new, and that growth has averaged 10% over the past 30 years. Unlike in India, all growth in China is driven by the government.

“I feel very bullish that China is going to grow — that they’ll surprise us on the upside,” he says. “They cannot stop. If they stop, they have a problem. A senior official told me China is like a bicycle: they have to keep pedalling or it falls over.”

If the Chinese government does not keep the economy growing at the current pace, it could face dramatic unrest. Perhaps more dangerous to the global economy, though, is that the country does not recognize the importance of the rest of the world, only its role in the current global expansion.

“God forbid the first time a U.S. kid chokes and dies on a Chinese product and Lou Dobbs gets a hold of that,” Bremmer says, referring to CNN’s outspoken advocate of U.S. protectionism. “That’s coming.”

Filed by Steven Lamb, Advisor.ca, steven.lamb@advisor.rogers.com