During the second quarter of this year, an almost-eerie calm has settled over markets. For the first time in more than 20 years, bonds, stocks and commodities all rose together, while volatility across all asset classes continued to decline to extremely low levels. This was especially unusual given the domestic economy’s contraction during the first quarter and the deterioration of the geopolitical situation, from Crimea to the Middle East to the South China Sea.
In the list of risks that must be considered for any investment, geopolitical tops them all because the political environment in a country sets the stage for the business environment. Today, however, the world is a much muddier place. Good and bad are no longer two dimensional but multidimensional. One country can be a good trading partner but politically hostile (China, for example), while another can be a good partner for security purposes but not one in which we invest.
The last several months, the news has been dominated by the crisis in Ukraine and the growing conflict in Iraq. Years ago, this could have been extremely impactful from an investment perspective. Today, however, markets are at worst twitchy, which speaks to how things have changed geopolitically, particularly as it relates to commodities and other sources of energy. Russia provides 24 percent of the European Union’s gas and 30 percent of its oil; however, greater energy independence for the US has inoculated the domestic recovery from a potential oil price shock. While not diminishing the human suffering that is occurring as a result of these geopolitical conflicts, from an investment perspective, they have in some ways created more opportunity than risk so far.
According to studies done by Research Affiliates, “After an average loss of 14% in the first three months of the conflict [investors] may be powerfully inclined to pull money out of the country.” Therefore, investments that are able to take advantage of this pricing were able to capitalize once markets stabilized. In short, opportunities exist when, to borrow from Warren Buffett, investors are greedy when others are fearful and fearful when others are greedy.
Our strategies have benefitted from this in our Safe building block. Earlier this year we established exposure to global bonds, selecting an active manager who positioned to take advantage of the distressed opportunities that Ukrainian bonds offered, adding yield to portfolios without introducing undue risk in portfolios.
We do not mean any of this to lessen the turmoil brought about by the current Ukrainian crisis. However, as investors, it is important to discern risks as they relate to investment portfolios. By seizing opportunities as they arise, we are able to increase returns in today’s low-yield environment.