How do geo-political events affect stock markets?

The word geopolitical is either misunderstood or not fully understood by most people. It is actually about the impact of global politics and global international relations on the stock markets. Geopolitics is extremely important as the markets globally get interconnected. For example, when Lehman happened, the entire global trembled. Similarly, when the US and Iran got close to a war in Middle East, it had its impact on oil prices on stocks. When Europe was on the brink of default in 2011, it roiled global bond markets and also equity markets went into a prolonged slowdown. Let us understand these geopolitical factors in much greater detail and how exactly they impact the stock prices.

Geopolitics essentially refers to different geographic influences on political and international relations. The virtually seamless interconnection between world markets helps in the transmission of the impact quite fast as we have seen time and again in the past. Here are some major geopolitical takeaways.

Key takeaways from geopolitical factors impacting stock markets

• Geopolitical factors are like beta drivers. Due to the mixed effects of currency and equity; performance could increase volatility in the financial market. In short it is a multilateral effect than just a unilateral effect. Most often, the impact is cascading.
• We need to clear one area of confusion here. Geopolitical factors are different than macroeconomic factors. Macroeconomic factors refer to interest rates, inflation, GDP, growth etc while geopolitical factors are all about global macro inter linkages and are often about politics and global relations than about economics.
• The global GDP and its growth is a critical factor impacting the health of stock market returns. For example, an increase in the GDP of developed markets will lead to better trade flow and will also lead to downstream positive effects. Remember, geopolitics is not just about negative events but it can about positive events too.
• Most geopolitical factors have the primary impact on the currencies in question. Any country that has a fixed-rate system (like we saw in the case of pegged rate systems in Asia in 1998) can shift its rate on the lower side. That can have a cascading effect on stock market in the world as we saw so eloquently in the case of South East Asia.
• Most of the geopolitical factors affect the interest rate over the world that in turn will impact the stock market. Take the case of the US Fed. India has little control over what the Fed does. However, Indian markets are deeply dependent on Fed actions. Any sharp rise in the US fed rates will result in a fall in the stock market because the money from corporate and retails will go to safer markets than stock markets. Similarly, we saw in 2013 how the US Fed indication that they would wind down their bonds portfolio had a cascading effect on global stocks.
• Geopolitical flows can also result in inflow slowdown. There are many investors in the market, who consider geopolitical factors as investing signs. Any negative impact of geopolitical factors is taken as a stop sign by these investors and leads to a decrease in the inflow of funds in the stock market. This impact is most visible in the case of ETFs as country funds that allocation on a macro scale.
• One more impact, we have seen in the case of the Greek crisis, is on the ratings of the market. Geopolitical factors help in providing a health check of the stock market and in identifying the capability of stock markets to sustain in geopolitical tensions. The capable stock markets will get a high inflow of FIIs, due to its ability to recover quickly.
• Geopolitical risks also have an impact on policy decisions and that has a major bearing on the stock markets. The policy decisions are taken considering such factors regarding international trade also impact the stock market. For example, trump’s policy on an H1-B visa is harmful to the Indian IT industry. The Chinese Coronavirus pandemic is likely to leave a deep impact on the pharma and the electronics segment.
• Finally, the geopolitical factors have a deep impact on the monetary policy of central banks and that has a major bearing on the stock markets. For example, if central bank increases the supply of money, companies will start to borrow more and invest more. On the other hand, if the Central bank curbs liquidity, economic growth will be hindered and that will have a downstream impact on the stock markets too.

The moral of the story is that geopolitical events and the stock markets are intimately related.

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