Geopolitical risk is the risk that an investment’s returns could suffer as a result of political changes or instability in a country.
In today’s complex global landscape, the world’s leading superpowers, the US and China, are clearly at a critical stage. The dynamics of their relationship set the tone for international politics.
Historically in times of rising geopolitical risk, investors flee to safety, causing equity markets to fall and bond yields to rise, which increases borrowing costs in the country affected.
Meanwhile, the Middle East remains a hotspot of geopolitical tension. Iran’s ongoing conflicts with Israel and Saudi Arabia continue.
Complicating matters, the Iranian-backed Yemen Houthis are entering the war with Israel as they have been firing rockets at Israel which were intercepted by the US.
The volatility extends to Israel, where a recent war that started on October 7th 2023 between Israel and Hamas has made the region more unstable.
This uncertainty has led us to reduce our investment in Nova Ltd, an Israeli leader in metrology solutions for semiconductor process control.
Eastern Europe is not without its challenges, as Russia and Ukraine are enduring a devastating war that has caused both economic and human losses.
There is also tension between China and Taiwan in the South China Sea. Exactly how far these tests of geopolitical risk will go is unknown.
The question is, in the event of an invasion by China, would the United States and its allies intervene to defend Taiwan?
The United States, grappling with its own geopolitical dilemmas, finds itself in a so-called ‘Thucydides Trap – a tendency toward war when an emerging power threatens to displace an existing great power as a regional or international hegemon.
It is important to note that there are several types of war. The US and China however have been engaged in a capital and technology war so far and this is expected to continue.
In response, the US has passed a bill that will cut off China’s access to the much needed artificial intelligence chips.
The fear is some of those sophisticated chips will be used by the Chinese military.
The most advanced chips such as 3nm are designed by US companies but manufactured by the Taiwan Semiconductor Company (TSMC) in Taiwan.
TSMC is currently expanding its manufacturing in the US as relying on Taiwan will make the US and other Western nations vulnerable if China invades Taiwan.
This strategic shift is to deter China from accessing those critical chips.
In response, China announced special export permits for three grades of graphite, used to make lithium-ion batteries for mobile phones and electric vehicles.
One argument is this might push China to speed up R&D for its own chips, as evidenced by Huawei’s latest phone using domestically produced chips.
China’s share of world trade is over seven times larger than Russia’s and constitutes nearly a fifth of all American manufactured goods imports.
Historically a war between the ruling power and a rising power is very difficult to avoid but the recent visit of President XI to the US marked the importance of peaceful coexistence.
President XI stated China and the US can actually be friends and partners and the results of conflict between the two is something both parties cannot afford.
This emphasises the greater role China and the US can play in making the world a better place by working together.
Several issues are currently confronting the world, including geopolitics, high-interest rates, debt and inflation.
We have seen the latest inflation figures are improving and the market is implying that there will be several rate cuts by next year.
It’s difficult to believe we will get to the Central Bank’s target which is 2% CPI inflation in the short term.
However, we see ourselves as business analysts not economists since economists do not have a good track record of predicting recession and inflation, we think it’s far more important to focus on the fundamentals of the businesses which we can assess and analyse.
This approach echoes Warren Buffet’s philosophy during his 54-year partnership with Charlie Munger, “We have never forgone an attractive purchase because of the macro or political environment, or the views of other people. In fact, these subjects never come up when we make decisions.”
It is important to note that macroeconomic events and the ups and downs of companies’ near-term fortunes are not necessarily indicative of, or relevant to companies’ long-term prospects. To put it into perspective, If you missed the best 10 trading days of the S&P 500 in the last 30 years, your performance would have been cut in half. So we should pay little attention to them.
YFS Intelligent Wealth Fund Performance vs. IA Global
Awet Ghirmay, Head of Investment Research
More information about our fund, the YFS Intelligent Wealth Fund can be found here: Hargreaves Lansdown or AJ Bell
Risk warnings: The value of investments and the income derived from them may fall as well as rise. You may not get back what you invest. This communication is for general information only and is not intended to be individual advice. You are recommended to seek competent professional advice before taking any action. All statements concerning the tax treatment of products and their benefits are based on our understanding of current tax law and HM Revenue and Customs practice. Levels and bases of tax relief are subject to change. This blog is based on my own observations and opinions.
