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Sunday 23 September 2018

Don't let Little Rocket Man or Trump sway your investment decisions

 

'Don't waste too much time worrying about the 'Little Rocket Man' or Mr Trump'
'Don't waste too much time worrying about the 'Little Rocket Man' or Mr Trump'

David Coffey

Geopolitical risk, most recently in the shape of a potential nuclear conflict between North Korea and the United States, is often put forward as a reason not to invest in financial markets. However, should we be worried about political events when making investment decisions?

At a recent presentation, one of Ireland's most experienced and respected fund managers made an interesting point about the world: When he returned from London in 1981 John Lennon had recently been killed, and Ronald Reagan and the Pope has been shot in failed assassination attempts.. Strikes and civil disobedience were the order of the day and the political system felt like it was breaking down. However, the early 1980s was arguably the best time in the last century to buy equities - the market went on a relatively uninterrupted bull run for the next 20 years. Between 1980 and 2000, the S&P 500 Index (a stock market index which includes the 500 largest companies in the US) rose by 1,261pc. The bull run was interrupted by a 35pc fall around the time of the stock market crash in October 1987, but the S&P 500 still managed to deliver a positive return of 5.8pc that year.

More recently, we have had two major political events which made a brief impact on markets: Brexit, and the election of Donald Trump. In the days after the Brexit vote, indiscriminate selling caused the world equity index to decline several percentage points, but the losses were quickly recovered. In the immediate aftermath of the Trump election, S&P Futures (a financial instrument used by investors to speculate on the future value of the S&P 500 Index) indicated that the US equity market would be significantly lower. Instead, the market rallied strongly throughout the day and has continued to rally, thereafter.

If nuclear war is your concern, the doctrine of mutually-assured destruction (MAD) should put your mind at ease. When two or more opposing sides face each other in a potential nuclear conflict, the likelihood that they will both end up destroying each other is the deterrent which prevents either side from taking action in the first place. However, accidents can never be ruled out and we came close to one such accident during the 1962 Cuban Missile Crisis.

Geopolitical risk is hard to quantify, and I doubt that many equity analysts are including the risk of a nuclear war in their risk models. When analysing a firm to invest in, it is best to focus on the following fundamental risks: business risk (the risk that, for whatever reason, the company's earnings will decline over time), financial risk (the risk of inappropriate financing or debt levels which could lead to insolvency or destruction of shareholder value) and valuation risk (the risk of overpaying for a company which could in turn impact or reduce potential future returns).

Throughout the 20th century and up to the present day, we have been through wars, oil embargoes, terrorist attacks, trade wars, currency wars, political protests, and many other political events. Through it all, the broad equity markets have continued to be driven by economic and corporate fundamentals as opposed to geopolitical events. There will always be risks and things to worry about when it comes to investing, but don't waste too much time worrying about the 'Little Rocket Man' or Mr Trump. As the famous financier, Baron Rothschild, once said: "When there's blood in the street, it's time to buy". For investors with a long-term time horizon, this is usually good advice.

David Coffey is an investment adviser with the wealth managers GillenMarkets (gillenmarkets.com)

Any investment commentary in this column is from the author directly and should not be seen as a recommendation from The Sunday Independent

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