Throughout 2019, global markets have been climbing a wall of worries including political shock events like UK Brexit, US/China trade war and the anti-government street protests in Hong Kong. These widely reported geopolitical events have already negatively impacted investor and company’s investment sentiment and many stock markets.
We view geopolitical events as un-avoidable and very difficult to predict as they involve human behaviour which can at times be quite irrational. Also, major macroeconomic shocks like recession are unavoidable as they are part of a business cycle in a capitalist economy. The market impact of these events are always difficult to predict due to human tendency to anticipate / extrapolate and herd mentality to over-react especially under stressful conditions. The good news is that shock events and their psychological impact on humans are mostly transient in nature. Most of the time, the world is peaceful, people are calm and the economy is in expansion phase.
We believe that the key to long-term investment success is NOT to try to time or predict these events, but to:
- Always be prepared for shocks by building an Multi-asset Class Investment Portfolio with assets that have low correlation to one another.
- Look out for new opportunities amid a crisis – In the Chinese language, the word “Crisis” is composed of two characters (危机), one representing danger and the other opportunity or change. We believe that risk/change always brings out new opportunities. A high risk investment with the right price can still be a good investment.
- Focus investments in countries with built-in resiliency against political and economic shocks and so you can stay invested and make profits in a down cycle.
Below we discuss the Top 5 characteristics that make a Country Resilient to Economic and Political shocks.
- Countries with lots of multinational companies – When a country is home to lots of multinational companies, its stock market’s net worth and growth prospects become less dependent on its own country’s market and GDP growth, but more tied to global market and global GDP growth. By having global revenue source and operations, these companies have high resilience to economic/political shocks in any single country or continent.
- Countries with established legal framework to let companies fail in an organized fashion – In a dynamic business world, companies have to continually evolve to survive or die. When businesses fail because of new tariffs, changing policies or during an economic downturn, it is better to let them shutdown in an organized fashion than to sustain them for economic stability and job preservation. Capital / labor should be allowed to move freely from failing enterprises to more efficiently-run and successful businesses. Countries with well-established framework and societal acceptance towards failing businesses will be more resilient to economic shocks as capital / labor can get redeployed in a more efficient and organized manner.
- Countries run by government with separation of powers – Investments are more favorable in countries run by governments with separation of power as they will have less corruption, and lower key man and policy risks. Even though they are less efficiently run, governments with separation of powers among the three branches (executive, legislature and judicial) provides “checks and balances” in the political process, continuity in the government and prevent concentration of power among its leadership. Most officials in these countries stay in power for 3-8 years so their individual actions can never have a material and lasting impact on the country.
- Countries with free currency exchange rate and independent monetary policy / interest rate setting mechanism – Currency exchange rates and interest rates are key components of a self-adjusting mechanism that allows a country to regulate its trade and capital flow with other countries and moderate its economy. If a country’s exchange rates and interest rates are somehow restricted or pegged, it could create all kinds of economic problems like asset bubbles and depressed economic growth. Countries with its own free floating currency and independent interest rate policy can use these tools to buffer any sudden shocks to support the economy.
- Countries with freedom of expression and free flow of capital/people – Freedom of expression and free movement of capital/people in a society act as pressure valves to let the steam out and avoid a potential explosion. Even though street protests and political demonstrations are unsettling to watch on TV, it is still better than having a “stable” society where citizens are afraid to speak their minds, social problems are covered up and rich people constantly trying to move their family members and money out of the country.
In an unstable world, investors always flock to “safe haven” markets that are perceived to have more adaptable, shock-resistant economies and companies that offer long-term, sustainable growth. One can easily identify these countries by looking at the year-to-date performance of various markets in 2019. We believe the above five characteristics help explain why certain country’s stock markets can justifiably command significant trading premium over and continue to outperform other more “rigid” country markets that have a much higher GDP growth rate.
As Warren Buffett once said:
“Only when the tide goes out do you discover who’s been swimming naked.”
In a bull market, all stocks including flawed businesses get bid up to unreasonable level as people buy them irrespective of valuation to look good in the short/intermediate term (herd mentality). When business conditions are easy and favorable, even flawed business models will temporarily show decent profits.
However, when business conditions worsen and the stock market corrects, it will become clear which companies have truly durable business models vs. which companies were just lucky during the boom times.
At Invision, we help our clients build the right shock-proof portfolios so they can stay invested and achieve financial independence no matter how unstable the world may become in the next 5, 10, 20 years.