Posted: June 01, 2011
How the geopolitical landscape affects your investments
A look at flashpoints, hot spots and other global security challengesBy Todd Hauer
In addition to the ever-present market risk investors must face, we are presently subject to heightened event risk due to political instability, especially in the energy-rich Middle East where the geopolitical landscape remains tenuous. This might require investors to adjust their portfolios asset allocation to adapt to these heightened risks.
Recently, I invited foreign policy expert Peter Brookes to Denver to speak about flashpoints, hot spots and other challenges to international stability and security. Brookes, a Senior Fellow for National Security Affairs with the Heritage Foundation, provided an overview of the unsettled global geopolitical landscape. The current environment might produce "Black Swan" events which are relatively unpredictable yet could have a major impact your investment portfolio.
Here is a brief look at the risks identified by Brookes: Iran's nuclear/missile programs, support for terrorist groups, and involvement in Lebanon, Iraq, Afghanistan and Middle East revolts; North Korea's nuclear/missile programs, nuclear proliferation, ongoing leadership transition, and acts of provocation; overall terrorist threats including Al Qaeda core, Al Qaeda in the Arabian Peninsula and homegrown terror and plots; Venezuela's Bolivarian Revolution, nuclear aspirations, ties with Iran and ties with FARC; in Pakistan and Afghanistan, the Al Qaeda, Taliban and Haqqani network, security of nuclear arsenal and Pakistani tensions with India; Russia's grand ambitions, energy prowess, the Arctic and military modernization, China's rising power, economic prowess, political clout, and military buildup.
How to Protect Your Portfolio
These "Black Swans" create heightened "event" risk and investors should discuss with their financial advisor how their portfolio is positioned to protect against these heightened risks. There are asset classes which, in the past, have performed during times of distress in the stock and bond markets. These asset classes are sometimes referred to as "alternative investments" because of their low correlation to stocks and bonds. Please remember, past performance is not a guarantee of future performance.
Be sure your asset allocation is consistent with your need for both return and risk management. You might want to consider weighting alternative investments more heavily in your portfolios during this period of instability. Avoid the temptation to "time" the markets. Rather, adopt an asset allocation which is consistent with your need for return and risk.
How to Cope with Uncertainty
Global events can certainly affect the U.S. stock market. Throughout its history, however, the U.S. stock market has proved to be quite resilient over the long term, bouncing back time and time again from the impact of world crises. Examining how some past global problems have affected the U.S. stock market may help you better grapple with the economic and investment uncertainties of crisis events.
Action and Reaction
It may reassure you to know that the stock market has historically rewarded those who stayed the course during tumultuous times, although past performance cannot guarantee future results. For instance, on the first trading day after the Cuban Missile Crisis (October 23, 1962), the S&P 500 fell 3.78%. Yet only six months later, it had surged 24.66%. More recently, over the one-month period after Iraq invaded Kuwait-a move that eventually led to the first Gulf War-the S&P 500 declined 9.12%. One year later, the index had jumped 10.16%.
Sometimes the market's rebound has been slower in coming. For instance, after the bombing of Pearl Harbor, the S&P 500 experienced an initial drop, rose slightly after one month and then found itself lower six months after the attack. But by V-J Day, less than four years later in August 1945, the S&P 500 had rebounded 57%.
Of course, economic developments take time to play out, and markets often remain highly volatile in the immediate wake of a world crisis. Aside from keeping history in mind, how might you cope in our ever-changing world? Consider these suggestions:
• Focus on your long-term financial plan rather than short-term market dips.
• Be realistic, but not fatalistic, about current market conditions and returns. Investors prepared for occasional declines will be less likely to fall prey to panic selling.
• Keep your portfolio well diversified to help cushion volatility.
• Get to know your finances better and review how different accounts-such as IRAs and employer-sponsored retirement plans-are invested.
• Review your portfolio and make sure that your risk tolerance meshes with your financial goals and time horizon.
Remember that while our nation has faced crises before, the economy and the stock market have recovered, in time, stronger than before.
Todd Hauer is a Wealth Advisor with the Global Wealth Management Division of Morgan Stanley Smith Barney in the Denver Tech Center. He can be reached at 720.488.2406 or toll free at 1-800-347-5099, or you can email him at Todd.Hauer@morganstanleysmithbarney.com.
Todd Hauer is a Financial Advisor with the Global Wealth Management Division of Morgan Stanley Smith Barney in the Denver Tech Center. He can be reached at 720-488-2406 or toll free at 1-800-347-5099, or you can email him at Todd.Hauer@morganstanleysmithbarney.com.