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After a fabulous 2019, where stocks, bonds and other investments climbed in concert, investors will have to manage their risk appetites in 2020 more carefully. Photo: AP
Opinion
Eye on Asia
by Olivier d’Assier
Eye on Asia
by Olivier d’Assier

How investors can ferret out risks from US-China trade conflict and the Iran and North Korea crises for a prosperous Year of the Rat

  • The smart investor will do well to loosen risk appetites for the first and final quarters, when trade war truce and US election results are likely to boost markets, but watch for heightened uncertainty in the second and third quarters from Iran and North Korea, and US electioneering
In the Year of the Dog, investors chased their tails over monetary policy. The Year of the Pig saw investors deep in the mud of the trade war between the United States and China. The Year of the Rat promises calmer days with the phase-one US-China trade deal signed and a Brexit plan materialising. But it could be a trap – which means time for a backup plan.

Consider the landscape. The issue of a potential trade war remains alive for US President Donald Trump’s re-election campaign under phase-two negotiations. This is a well from which Trump’s campaign will want to drink again and again in 2020.

But there is another front in US relationship woes with the rest of the world: its security issues with Iran and North Korea, which make armed conflict and security a new focus of investors’ attention.
Indeed, the new breed of politicians epitomised by Trump and British Prime Minister Boris Johnson are challenging not only domestic institutions and political conventions, but the very foundations of international relations and diplomatic rules. This disruption is set to continue in 2020.

But perspective and equanimity are needed. There is only a minute chance of a full confrontation between global military powers, and small regional armed conflicts typically have no lasting effect on economic fundamentals. Markets react but small conflicts tend to be isolated and short-lived. In the face of strong economic fundamentals, they actually turn out to be good buying opportunities.

Take the first week of the year for example. On Friday, the US killed Iran’s top general Qassem Soleimani. On Saturday, Iran vowed to retaliate. On Monday, Iran sent ballistic missiles to military bases hosting US personnel, before “standing down” on Wednesday.

By the following Friday, markets had recovered all losses from the knee-jerk reaction and were looking again for new highs. Years from now, an analyst looking at the week’s market data would be completely unaware that we came close to war.

Far from shrugging off Iran crisis, markets are rooted to the spot

But is it over? Probably not. Iran has threatened more retaliation, including against European forces in the region. It also said it was enriching more uranium than before the nuclear deal. This is an issue likely to return to the front pages now and again, especially during an American election year.
Then there is North Korea’s Kim Jung-un, who is denouncing the deal Trump offered last year in exchange for sanction relief and hinting that he may resume long-range missile testing and nuclear weapons research.
And let us not forget mother nature, the wild card in any year. The Australian bush fires, which started last September, are a stark reminder of its potential for disruption. Yet the Australian stock market is up some 6 per cent since the start of September.
So, what does it all mean for investors in the Year of the Rat? The consensus seems to be that we have hit bottom and may start to rebound with the restart of global trade. Inflation does not seem to be a concern, keeping central banks accommodative. And the mighty consumer is still spending. This all helps explain successive record highs by markets on healthy volumes, but will that last given the geopolitical risks?

In the new normal of unpredictable politicians, trying to forecast an escalation/de-escalation of geopolitical crisis is not only impossible, it is unprofitable and unadvisable. The best approach is scenario planning based on changing risk appetites and to adjust your risk budget for the year.

The first quarter calls for more risk tolerance with the trade war truce, war with Iran averted, diplomacy in action with North Korea, and positive early earnings and retail sales numbers. Fourth-quarter earnings season getting under way means investors’ focus will return to company fundamentals.

The second and third quarters are a good time for higher risk aversion. Iran and North Korea could make good on their threats and with Democrat and Republican national conventions (July and August) coming up, US electoral rhetoric could become acrimonious and divisive. The US administration may look to use a foreign threat as a rallying cry. Low volumes during the summer months can lead to overreaction on risk events.

The fourth quarter, which will see US election results, might see increased risk tolerance. A boost is likely in the form of higher confidence or a relief rally after months of uncertainty.

The Year of the Rat could be a barbell year, with investors likely to see higher risk-adjusted returns in the first and final quarters, while heightened uncertainty in the second and third quarters drives risk up and returns down. Not reacting to sensational news may be the best fortune to follow for a new and prosperous lunar year.

Olivier d’Assier is head of applied research for global financial intelligence and analytics firm Qontigo

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