[Geopolitics] China and the U.S. are wrestling, is it a crisis or an opportunity for the stock market?

US "911" incident 

After the 911 incident occurred in the United States in 2001, the U.S. market closed on the same day and did not open until the 17th. This became the longest U.S. stock market closure after the Great Depression. The Federal Reserve announced a 0.5% rate cut (from 3.5% to 3%) on September 17. After the stock market reopened on September 17 (Monday), the Dow Jones Industrial Average fell 7.1% from 9606 points on September 10, and fell to its lowest point of 8236 points on September 21, down 14% from September 10. Since then, it has gradually risen, closing at 9608 on November 9th, surpassing before the "9.11" incident. Since then, the U.S. stock market entered a bull market until the 2008 financial crisis, and after the financial crisis, it has entered the "long bull".

Sino-US trade conflict

There are constant trade conflicts between China and the United States, and the stock market will fluctuate after each occurrence. One of them was on March 23, 2018, when US President Trump issued a huge trade "ticket" to China: the value of imports from China Up to 60 billion US dollars of goods are taxed. According to the White House press release, the United States will impose 25% tariffs on aerospace, information and communication technology, machinery and other products.

After the news was announced, European stock markets closed sharply, the pan-European Stock 600 index closed down 1.64%, and all sectors fell sharply at the end of trading. At the same time, the French CAC 40 index fell 1.59%, and the German DAX index closed down 1.81%. Affected by this, the U.S. stock market is also under tremendous pressure, and the Dow Jones Industrial Average has fallen by 724 points (2.93%). But on the next trading day, the Dow Jones Industrial Average has risen from a low opening price of 23,825 to a closing price of 24,202.

Closure of the Chinese Consulate General in Houston

On July 22, the United States suddenly requested China to close the Consulate General in Houston. The market worried about the deterioration of Sino-US relations. Hong Kong's Hang Seng Index fell sharply since 3:20 pm, fell 250 points within half an hour, and finally fell 500 points or 1.95%. The Dow in the US stock market also turned from rising to falling in about the same time, falling 135 points in half an hour to 26658 points. However, the Hang Seng Index did not fall again the next day after experiencing a sharp drop. The Dow also stabilized and the upward trend continued.

How to invest under the geopolitical crisis?

Geopolitical crises usually cause investors to transfer risky assets such as stocks into assets they consider safer, such as gold. Of course, this will also affect stock market returns, and government bonds will benefit from this (especially short-term bonds, because Short-term bonds are considered the safest assets). As shown in the figure below, we can observe the impact of the past three geopolitical crises on the performance of four different assets: US stocks, global stocks, gold, and US government bonds.

In addition, Keith Wade and Irene Lauro, chief economists at Schroeder, observed five peak periods of geopolitical crisis since 1985. Their analysis shows the performance of the “safe” portfolio in the short term, see the chart below.

Consider hybrid investment portfolio

The analysis found that most risky portfolios performed better during the 6-month observation period. It's just that investors must bear considerable volatility before realizing asset profits. Therefore, economists adopted a hybrid dynamic portfolio: that is, when the geopolitics is gradually tightened (after the geopolitical crisis index rises to 100), the security portfolio is first adopted, and after the crisis is eased (the index is below 100) Then transfer the position to the risky portfolio. This strategy may not be practical for individual investors, but it is the best choice for active fund managers with flexible adjustments and their investors.

Keith Wade said that since Trump assumed the presidency of the United States, geopolitical risks have increased significantly. The rise of China and the rise of populism in various places have made geopolitical risks high, and there will not be much change in the short term. He emphasized that the low interest rate environment and observing the balance sheets of central banks show that central banks can respond to geopolitical risks with fewer means than in the past. Therefore, it is very important for investors to take geopolitical risks into consideration when making investment strategies.

Political instability may provide market entry opportunities

Finally, geopolitical events may cause short-term fluctuations in the financial market, but after the market has digested the news, confidence rebounds and market fluctuations will calm down. Geopolitical events will not change the mid- to long-term stock market trend, but it will affect short-term stock market performance. If there is an "overshoot" in the financial market within a short period of time, it may be a good investment opportunity. Some optimistic investors even believe that political instability has caused volatility in the stock market, which instead provides opportunities to enter the market.