Macroscope | With Mideast on brink, investors ignore geopolitical risks at their peril

If investors are indeed concerned about geopolitics, their fears are not reflected in the market as equity investments remain at all-time highs

An escalation between Iran and Israel would disadvantage emerging market currencies, fan inflation and widen the gap between asset prices and the real economy

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Members of the Iranian military march during an Army Day parade in Tehran on April 17. During the parade, President Ebrahim Raisi said the “tiniest invasion” by Israel would bring a “massive and harsh” response, as the region braces for further escalation. Photo: AP

Published: 6:30pm, 18 Apr 2024

Investors are often accused of being complacent about vulnerabilities in the global economy, particularly geopolitical risks which have not been this acute in decades. Yet this is only partly true. A cursory glance at surveys of market sentiment suggests investors are increasingly concerned about the dramatic escalation in geopolitical tensions in recent years.

Since the beginning of this year, respondents to Bank of America’s global fund manager survey have cited geopolitics as one of the most important “tail risks” in markets along with higher-than-expected inflation. Indeed, over the past decade, geopolitical risks have figured prominently among the biggest concerns of investors, according to the survey’s findings.

Yet, traders have a tendency to say one thing and do another. As JPMorgan noted in a report on Monday, “equities remain significantly higher [year to date] and continue to hover around all-time highs, while credit spreads are trading at or near post-[2008 financial crisis lows]”.

If investors are worried about geopolitics, their fears are not reflected in asset prices. Moreover, the parts of the markets that are under strain, such as US Treasury bonds and emerging market currencies, are suffering not because of geopolitical risks but because of investors’ belated realisation that the US Federal Reserve will struggle to cut interest rates this year.

Markets are notoriously poor at assessing and pricing geopolitical risks, especially low-probability, high-impact events such as wars. Discounting these type of threats is often the right thing to do. Unlike financial risks, all-out military conflicts are binary: either the status quo endures or things take a dramatic turn for the worse, in which case every asset is at risk.

Yet taking the view that the most severe geopolitical risks are the ones that should be ignored or downplayed is misguided. At a time when the global economy is weak and vulnerable, stock markets – especially in the US – are priced for perfection and the world’s most influential central bank is signalling that it will keep borrowing costs higher for longer, geopolitical risks matter more than ever.