The current political and geopolitical turmoil only provides further reasons to consider maintaining a domestic bias.
Image: Photo: Bloomberg
By Kondi Nkosi
Current political circumstances and geopolitical events can always provide reasons for investors to think twice about diversifying globally.
But is that thinking valid? A closer inspection reveals it may not be.
Even before this year’s political news took shape, investors may have been concerned about global equities.
The outsized performance of the “Magnificent Seven” (Alphabet, Amazon, Apple, Meta, Microsoft, Nvidia and Tesla) has left the US equity market focused on a small group of mega-cap tech companies, while their performance has left major global equity indexes highly concentrated in the US.
The current political and geopolitical turmoil only provides further reasons to consider maintaining a domestic bias.
The daily headlines are filled with ominous news about tariffs, and the overall global state of geopolitical tension is high.
Are these sufficient reasons for investors to avoid or minimise exposure to global equities? In our view, they are not, and in fact there are plenty of reasons to stay globally diversified.
Increased US tariffs affect economies around the globe, and they could lead to a greater weaponisation of trade in the pursuit of political objectives.
A key point to remember, though, is that not all countries will be affected similarly. Some regions, and leading companies within them, could benefit from the disruption the trade battles create.
As evidence of this, amid the US-China trade conflict that played out during the first Trump administration, a number of “bystander countries” – including Vietnam, Thailand, South Korea and Mexico – were able to increase their exports to the US by offering substitutes or complementary products for those that China had previously been providing.
Further, sectors and companies that have a more domestically focused market will be shielded from much of the tension with international trade. The domestic focus is pronounced among small- and mid-cap companies.
Major events, such as the September 11, 2001 terrorist attacks against the US or Russia’s invasion of Ukraine, often cause an immediate, major market downturn.
But historically, the drop after such events has not lasted long, even for the world’s largest equity market in the US. It does not appear that such events warrant a complete reconsideration of any long-term investment strategies, including global diversification.
The daily political news that can cause short-term volatility in markets does not drive long-term equity returns. Company fundamentals, like earnings, do. Over the past 20 years, there has been a close correlation between the performance of the MSCI All Country World Index and the 12-month forward earnings per share (EPS) estimates for its constituents, demonstrating how closely stock returns track projections of earnings growth.
While global events can, of course, impact earnings, the other factors that can influence a company’s profitability – like its competitive positioning in is industry, the quality of its management team, and the strength of its balance sheet – are likely to play a far more critical role in how well a company fares amid constantly evolving market conditions.
Amid the market turbulence that alarming geopolitical news can bring, investors may be tempted to stay on the sideline or maintain a domestic market focus. Thirty years of recent history, though, demonstrate that global equities have often done quite well even amid the major geopolitical developments that brought some short-term volatility for global stocks.
Passive managers have to mirror an index and do not have the freedom to apply any judgement about how long-term trends are impacting markets. Active management allows for the flexibility to increase or decrease exposure to the countries, sectors or individual companies whose fortunes may be impacted differently by the trends influencing markets. It is also critically important to differentiate between the short-term developments that create noise in the markets and the long term-trends that may have a lasting impact.
Worrisome political environments and geopolitical events certainly foster a temptation to remain cautious until whatever current storms are brewing might pass. But the market volatility that events on the world's political stages can create has not historically persisted over long periods. Some of that short-term market turbulence may even create opportunities that can be taken advantage of by long-term investors.
Other factors, like extreme market concentration and the comparative discounts available on non-US stocks, could have a much greater impact on the long-term outlook for global equities. For investors, any current political or geopolitical conditions do not seem to warrant missing the opportunities that can be realised from portfolios that have the flexibility to seek out the best opportunities in the world, wherever they may reside.
Nkosi is South Africa country head for global investment manager Schroders.
BUSINESS REPORT