How does geopolitics affect asset allocation?

Above all, we need to distinguish between geopolitics and geopolitical crises. By its very nature, a geopolitical crisis is a factor that cannot be quantified, modelled or controlled. We must therefore consider it as an exogenous factor in asset allocation. In fact, it has always been at the top of the list of “conceivable” risks for all strategists and economists, every quarter and every year. In other words, we need to bear in mind that geopolitical risk can interfere with our assumptions and scenarios.

Keeping a cool head

Historically, the geopolitical crisis factor has tended to provoke a short-term market shock (increased aversion to risk, leading to re-correlation and a fall in risky assets). This is in contrast to the financial crisis, which has a real “disruptive” effect on the markets and often completely reshuffles the deck… It is above all an emotional factor. So, when an event occurs, it’s important to separate the human from the manager! Without being cynical, the short-term turbulence caused by the geopolitical crisis on the markets is often a source of opportunities, such as a spread widening on the bond market or a sudden fall in the equity markets.

A particular geopolitical context, or the emergence of a geopolitical crisis, structures the markets over the longer term because it is accompanied by economic and financial consequences. But it is impossible to hedge against geopolitical risk itself. The best “hedge” against geopolitical risk remains portfolio diversification and a dynamic approach to take advantage of volatility shocks.

Increasingly frequent crises

It’s worth pointing out that, for several years now, we have been living through a period in which the occurrence of geopolitical crises has increased. As allocators, we can see this as a more volatile market environment overall, with more frequent periods of re-correlation between asset classes.

The recent conflict between Israel and Hamas is unfortunately “just” the intensification of a historic geopolitical context. The economic and financial consequences will certainly depend on whether or not the conflict spreads: support for Hamas from certain states, potential economic and financial sanctions, etc. The adjustment variable today is essentially oil. Lastly, these rising tensions in the Middle East come at a time of macroeconomic uncertainty (monetary policy, “recession – stagflation – soft landing?”, the Chinese slowdown), low equity market valuations and earnings releases. A degree of risk aversion is likely to set in for a few weeks, favouring the most defensive segments. However, the consequences for asset allocation remain minor compared with those arising from the conflict in Ukraine.