Welcome to Soundbites, weekly insights on market trends and investment strategies, brought to you by Investment Executive and powered by Canada Life. For today’s Soundbites, we’re talking about geopolitical risks and how advisors should navigate them with Leonie MacCann, head of multi-asset solutions, portfolio manager with Keyridge Asset Management. We talked about price mismatches, common navigation mistakes and the impact on fixed income. And we started by asking what keeps her up at night.
Leonie MacCann (LM): Geopolitical risks in isolation don’t tend to be the biggest risk to markets. What you’ve seen through history is that geopolitics typically have a fairly limited impact on markets. However, oil shocks have been the exception and have contributed to equity market drawdown. The risk here is if a geopolitical event creates a sustained economic shock — particularly through energy, inflation or supply chains —there is a greater risk of a policy mistake. Our base case through the current conflict in Iran has — and continues to be — that you will see a resolution, and the Strait of Hormuz will reopen. If you were to see this more benign scenario coming through, we think you would see oil coming back down to around $85 to $90 a barrel. So still higher than pre-conflict, but these are much more manageable levels, and I think inflation and growth fears will fade away.
Tuning out the noise
LM: When trying to distinguish between geopolitical noise and risks that generally alter the investment thesis, the key question is, does it change the fundamentals? Markets are continually seeing geopolitical headlines, but most haven’t materially altered earnings, liquidity, growth or the long-term direction of the economy. And that’s what you’ve really been seeing in the market recently. You’re seeing strong and robust earnings. For Q1, we’ve now seen about 80% of the S&P 500 companies reporting a positive earnings surprise. And the earnings growth for the quarter is currently running at a rate close to 28%. So, really strong earnings coming through. There will always be volatility in markets, whether that is driven by geopolitical noise or other noise. But to manage this, we really come back to our core belief in having a long-term focus to try and help you look through that noise and build resilient portfolios.
Common navigation mistakes
LM: The biggest mistake is reacting emotionally to short-term headlines. You know, Warren Buffett famously once said, ‘Markets are essentially a device for transferring money from the impatient to the patient.’ So having that long-term focus is going to be absolutely key, trying not to react in the moment, but ensure that you have built a resilient and robust portfolio that can navigate a range of different market environments, because no single asset class or single market is going to be able to navigate every different type of environment. And the other thing is investors sometimes often underestimate second-order effects. So, while geopolitical risks create political uncertainty and, indeed, risks in the market, they can also create opportunities as themes start to emerge. Hence, the importance of really focusing on having a robust portfolio but maintaining a level of nimbleness at the same time.
Diversification tactics
LM: Correlations can temporarily move towards 1 during acute risk-off periods, but diversification still matters in these kind of environments because different assets will recover differently and respond differently as shocks evolve. We really believe in deep diversification and diversification being one of the most effective risk-management tools that you can use. This doesn’t mean just being diversified by different regions, but really looking to diversify across different asset classes, sectors, and investment styles as well. And, also, we think having explicit risk-management strategies can also be a really useful tool. Having a strategy in your portfolio that has inbuilt protection for when markets sell off. One example of this is the use of put options. What matters is not just about having more assets in your portfolio, but it’s really trying to make sure that you’ve got genuinely differentiated return drivers, because in a more fragmented world, deep diversification and risk management become even more important.
Managing fixed income
LM: What’s really interesting at the moment is the market trying to decipher whether we’re in boom or doom. You’re seeing two different reactions in the equity market and the bond market to the current conflict. In the equity market, we’re seeing a very strong rally and markets hitting new all-time highs. Why is this? Well, I’ve mentioned, it’s really due to the strong earnings and the economy being supported by that extraordinary AI capex spending boom. Whereas if you look to fixed-income markets, bond markets are leaning a bit more towards the doom. And what you’ve seen is that bond yields have edged higher. Bond investors naturally — because they’re dealing with debt — will have a viewpoint of what could go wrong. And what bond investors are concerned about is that the Strait of Hormuz has remained closed, and that could lead to higher oil prices for longer, which could ultimately lead to sustained higher inflation, or even stagflation concerns. Bond investors have pushed yields up higher on the back of that and are expecting central banks to hike rates rather than what we saw at the start of the year, where there were expectations of rate cuts coming through, particularly in the U.S. It is a good question, what central banks are trying to work out at the moment. Central banks have been on a wait-and-see mode. We’ve seen that from the Fed in the U.S. We’ve seen it from the ECB. We saw it from the Bank of Japan and the Bank of Canada as well.
And finally, what’s the bottom line on navigating political risk?
LM: The world is becoming more geopolitically complex, not less. So, when advisors are talking to clients about geopolitical events, I think it is really important to acknowledge uncertainty but without amplifying fear. While uncertainty can bring volatility, it does also bring opportunities and we’re already seeing themes start to emerge in this new geopolitical era. The most important thing is staying disciplined, diversified, and focused on the longer-term investment thesis, rather than reacting to every market-moving headline. And I keep mentioning that, because I think it really is key. Investors need portfolios that are built for resilience.
Well, those are today’s Soundbites, brought to you by Investment Executive and powered by Canada Life. Our thanks again to Leonie MacCann of Keyridge Asset Management. Visit us at investmentexecutive.com, where you can sign up for our a.m. newsletter and never miss another Soundbite. Thanks for listening.
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