The news that President Trump would impose tariffs on select European countries, in order to apparently prise Greenland from the control of Denmark, was one the latest in a series of disruptive developments emanating from the White House.

While those measures were subsequently withdrawn, they still presented a grave escalation in the vandalization of the old, globalized world order, and the departure towards a harsher, mercantilist world where the idea of ‘spheres of influence’ is attractive to strong men.

For Europe, this is another episode in casual bullying by the US president, which has occurred in the context of active undermining of Europe by Russia, and economic dumping by China. Europe is under siege.

As citizens we are deeply concerned, and as investors we ask how best to position portfolios in the context of increasingly disruptive geopolitics. This year we have already had an incursion into Venezuela (long-term implications for oil) and a politically motivated summons for the head of the US Federal Reserve.

Geopolitics and markets

In general, geopolitics has not tended to impact asset prices during the era of globalization (for part of which quantitative easing helped to dull the pain of geopolitics), and neither has it impacted private assets. This was up until the first Trump presidency (and subsequent Biden administration) when there was something of a forced separation of American and Chinese capital.

Now the financial and economic context has changed quite dramatically. Trade and financial relationships are breaking down and supply chains have taken on a geopolitical tilt. Historically, the US and most other major developed economies have enormous debt loads and large deficits, and together with stubborn levels of inflation (affordability is the main political issue in the USA), this makes for a more fragile financial backdrop. Indeed, with Japanese and US bond yields rising recently, we suspect that markets are more vulnerable to geopolitical shocks.

Portfolio implications

To that end, we examine geopolitical risks in terms of their first and second order macroeconomic effects, as well as their ability to upset specific asset classes. From that point there are several ways to incorporate geopolitical risk in portfolios (public and private).

One is through very specific sectors and stocks — with the defense sector being the most obvious current example, not to forget cyber stocks and rare earth companies. These firms are found in public as well as in private (venture) markets. In Europe, the vast re-armament of the continent will be done through largely private vehicles and will have spillovers to other segments like infrastructure.

A second one is to take a very long-run view that geopolitical risk will do to bond markets and currencies. As a historical case study, Turkey is a good example of a country where the undermining of institutions such as the judiciary and the central bank, has severely weakened the currency and bond markets. Many investors are starting to position for the same type of effect in the US, with the dollar still close to long term highs. At the same time, some currencies like the Swiss franc, tend to be safe havens in the context of geopolitical risk.¹

Hedging strategies

The central role of the US in financial markets (US equities make up over 65% of some equity benchmarks²) and the role of the dollar as the reserve currency, in the context of a more disruptive foreign policy, make some hedging strategies more obvious. Hedging dollar exposure and trimming expensive US equities in portfolios are examples of these strategies, given the risk that the US becomes a less attractive trade and diplomatic partner.

Arguably, within a portfolio of US assets, substituting internationally exposed equities for mid-market focused PE (less exposed to geopolitics) is another way to gain business cycle exposure, without exaggerated geopolitical risks.