Geopolitical Risks!?

Oftentimes, news headlines about a particular day’s market movement highlight geopolitical risk as a reason for price volatility. Last week was action-packed in terms of geopolitical risk. It included a surprising announcement by Vladimir Putin, impeachment trial machinations in the U.S., and the trade deals with China (“Phase One”) and United States-Mexico-Canada Agreement (USMCA). Because geopolitics are a factor in how assets are priced (the higher the perception of risk, the greater the impact on asset prices), it is an important part of how we view markets and our investment strategy.

Russia

Last week, Vladimir Putin announced some surprising and unexpected constitutional changes to Parliament. These seemed to be an attempt to solidify his control over Russia’s politics and the economy well beyond the end of his term in 2024. His announcement included the resignation of Dmitry Medvedev, the current prime minister, and many in his cabinet. Some analysts believe this paves the way for Putin to become the prime minister in 2024, as he was in 2008. Others believe the powers being given to the “State Council” (an advisory body to the president) would allow Putin to rule from within that body because it would be advisor to the head of state.

Either way, the move seems to be a power grab and, like Xi Jinping’s (China’s premier) proclamation last year, an indication that Putin isn’t interested in abdicating power any time soon. If there is good news in this announcement, it’s that the head of state in Russia will likely remain the same for some time, and that makes its direction clearer. However, as Putin has made clear, he is interested in acting in direct opposition to U.S. foreign policy, and this can be expected to continue.

We would expect fewer open Russian markets and greater state control of industry going forward.

China

President Trump signed Phase One of the China trade deal with Vice Premier Liu He in Washington D.C. last week. This removes the uncertainty surrounding this first step. However, it should be viewed as only a first step, and the Trump administration admitted as much by referring to it only recently as a Phase One deal. This makes it clear that more steps will be needed to arrive at the U.S. long-term goal, which is a more open Chinese economy and a Chinese government that does not support the piracy of intellectual property.

Just as the trade row last year took down the growth rate of the economy, this first phase should be additive. With a reduction in tariffs on $350 billion in goods, we should expect some improvement. Tariffs will remain elevated, however – over 19% on average.

China also agreed to $200 billion in greater purchases of goods over the next two years. This includes $50 billion in agricultural products and almost $80 billion in manufactured goods. Specifics about when and how were left out of the agreement. Still, the deal reduces tariffs overall, increases purchases and offers some approach to resolution should intellectual property theft occur. In all, this should boost economic growth by one-tenth of a percent or two in 2020.

It isn’t likely that China will work hard toward a Phase Two deal as the election year grinds on. They will survey the political winds and determine if they are going to be negotiating with the same administration in a year. As a result, we may see some market volatility as the election nears, given the differences in approach between candidates. One thing is for sure: the Trump administration will be touting progress with China on the campaign trail.

USMCA

Last week, the Senate approved the USMCA agreement 89-10, following House approval in December. According to the Office of the Trade Representative, “The U.S., Mexico and Canada have reached an agreement to modernize the 25-year old NAFTA into a 21st century high-standard agreement.” The agreement improves intellectual property protections and provides for expanding trade, including digital trade. There are provisions for more openness for financial services organizations to operate across North America. Finally, labor protections are meant to improve labor markets in all countries. In particular, the agreement supports North American jobs by requiring that 40 to 45% of auto content be made by workers earning at least $16 USD per hour.

Because the Trump administration made this a central issue during the 2016 campaign, it will be touted as a big success.

This agreement should be accretive to the U.S. economy and remove some uncertainty surrounding two large trading partners. According to CSIS research, the added benefit will be between $50 and $100 billion while adding 176,000 jobs. Trade overall with both countries should grow by 6% to 7%. Finally, the new agreement provides for digital trade provisions which didn’t exist in the early 1990s.

The deal adds to economic growth and removes some geopolitical uncertainty, both of which should be good for markets.

Europe

This week, President Trump and his trade team were in Davos, Switzerland, where they took a victory lap over the China and USMCA deals and then dropped a bomb on attendees, noting that, “The trade deals with Europe are worse than China.” This suggested that we will be hearing a lot more about trade during 2020; the target of tariffs and negotiations, however, will be across the Atlantic.

Not every week is as exciting when it comes to geopolitical events. However, in a low interest rate, monetary policy-fueled stock market like this one, it pays to understand whether geopolitical risk is moving higher or lower.

ABOUT THE AUTHOR

Brian Andrew

Chief Investment Officer | Johnson Financial Group

As Chief Investment Officer, Brian Andrew leads Johnson Financial Group's investment strategy to provide consistent, actionable investment solutions for our clients.