Investing and geopolitics (and Russia).
How geopolitics impacts markets, plus: what’s going on in Russia?
In this week’s edition of Not in Dispatches, we’ll be looking at why geopolitics matters for investors.
As regular readers know, Not in Dispatches is a weekly examination of the issues that sit in the background to our work, rather than an update on global events, which you’ll otherwise find in our Daily Assessments.
With the news of the purported mutiny in Russia, however, we wanted to quickly provide some initial thoughts on the evolving situation, which we will then return to in our usual fashion on Monday.
A riddle, wrapped in a mystery, inside an enigma.
Anything that happens inside Russia and that takes the Kremlin by surprise is something Western analysts are not going to have much insight on.
We can, however, interogate some scenarios and employ structured analytic techniques to turn the rumours, the social media posts and the snippets of news into something vaguely useful (we’ll write more on these methodologies in a future Not in Dispatches).
From that process we can say the following:
Firstly, this is not a coup, nor a civil war. Neither Yevgeny Prigozhin, the head of paramilitary Wagner Group, or the Kremlin are calling it as such. Instead, from the limited information we have, it appears to be a mutiny with the aim of displacing Russia’s military leadership with (presumably) Prigozhin and his cronies. Putin has described it as “treason” and a “stab in the back.”
Secondly, Prigozhin’s 25,000-odd mercenaries do not have the capacity to take Moscow, let alone a country of 11 time zones (they barely took Bakhmut, and to do that relied heavily on the same military they ostensibly wish to displace). They may have seized the regional headquarters in Rostov-on-Don, a city of 1 million close to Russian-occupied Ukraine, but that doesn’t give them access to the Southern Military District’s nuclear arms, the Black Sea Fleet, or anything like that.
Thirdly, this will diminish Vladimir Putin – events of this nature simply don’t occur in “normal” functioning countries – but there are real upsides for him if and when Prigozhin is neutralised (and we expect he will be neutralised). Indeed, we can think of at least four silver linings: a popular free radical will have been removed (Prigozhin’s defenestration would have elicited outrage had it happened just days ago); Putin will be given a degree of political cover for general mobilisation, should he wish; Putin will be given an excuse should his war in Ukraine fail (blame the traitors of Wagner); and, Putin will be able to utilise Wagner’s footprint in Africa and the Middle East (should that footprint survive).
Finally, don’t believe what you see this weekend. Actors inside and outside Moscow have a strong incentive to hype the situation and draw early conclusions of what it means for Ukraine, for NATO, for the US and for China. This is also fertile soil for conspiracy theories. We’ve read everything from Prigozhin being a CIA asset to this being a game of three-dimensional chess played by Chief of General Staff Valery Gerasimov. Perhaps the real reason is that Prigozhin has just had a brain snap. Judging by his erratic social media behaviour this doesn’t seem unlikely.
In sum, the events of the last 24 hours may mean a turning point for the war. Or they may just mean another actor has been removed in the endless court intrigue (i.e. gangland drama) of Putin’s circle. This is not Russia’s first mutiny and it won’t be its last. With a few very notable exceptions, the Kremlin is generally good at resolving these kinds of things. We should hopefully have a better idea on Monday (and what it means for business).
Written by former diplomats and industry specialists, Geopolitical Dispatch gives you the global intelligence for business and investing you won’t find anywhere else.
And now for something completely different…
Geopolitics and investment
Last week, we covered why geopolitics matters for people working in businesses – not just CEOs and directors but across many different corporate functions.
In some ways, it follows naturally that if geopolitics affects businesses then it must also affect markets.
The more interesting question is, “How?”
Geopolitics and company valuations
Most fundamentally, geopolitical events impact the key valuation drivers for nearly all financial assets. One of the standard ways used to estimate the value of an investment – whether bonds, stocks, real estate, private equity or infrastructure – is by calculating its expected future cash flows, the real risk-free rate, the expected inflation rate and the risk premium.
Geopolitical developments can alter all of these values. Political uncertainty and policy measures driven by geopolitics can drive up risk premiums. Wars and trade barriers can ramp up inflation, as Russia’s invasion of Ukraine has done. And economic policies aimed at containing or confronting geopolitical rivals – like tax incentives, subsidies, sanctions and trade embargoes – can all reduce future cash flows.
Having a grasp of the geopolitical factors behind government policies can therefore provide a significant edge in more accurately pricing financial assets, determining if they are under- or over-valued, and getting ahead of markets.
Geopolitics and industry-wide impacts
Beyond affecting asset valuation fundamentals, geopolitical events often have a particularly pronounced impact on a particular industry or sector that may unwittingly become swords or shields in geopolitical combat.
Over the past few years, US-China tensions have seen their respective governments identify and protect what they see as “strategic sectors” – whether semiconductors, raw materials, critical minerals, advanced technologies or defence. Understanding these states’ national security pre-occupations can provide insights into what industries are likely to be supported through measures like subsidies and tax breaks, become the target for offensive measures like sanctions and trade restrictions; and/or are likely to grow through greater demand from government procurement.
An even cursory look at major governments’ national security priorities, projected defence spending and the evolving lists of allies and marriages of convenience can help investors identify industries and sectors worth investing in. But in a rapidly changing global environment, shifting political allegiances and greater geopolitical uncertainty, affected industries are constantly changing.
Similarly, geopolitical events can damage some industries but benefit others. A terrorist attack, for instance, often leads to sustained losses in travel and insurance while defence, pharmaceuticals and commodities often do better. Keeping on top of changes through close monitoring of geopolitical events is therefore vital to identify what to buy and sell, and when.
With the brevity of a media digest, but the depth of an intelligence assessment, Daily Assessment goes beyond the news to outline the implications.
Geopolitics and the broader economy
Geopolitical disruptions can also have economy-wide impacts. An outbreak of armed conflict or a terrorist attack often has significant, but short-lived, impacts on overall sentiment. The mere anticipation of conflict can seriously affect financial assets – by depressing stock markets, driving down government bond yields, and lifting gold and oil prices.
Rivalries and tensions between major energy and commodities producers can also have major economic impacts. Russia’s invasion of Ukraine and the subsequent imposition of Western sanctions and turning of Russian exports towards Asia (including oil at a discount) has not only affected the value of Russian companies and the overall performance of Russian industry, but it also has significantly affected global oil and commodity prices, with a wide range of consequences.
Industries that benefit from higher commodity prices have generally done well, whereas for many producers up the value chain, this has meant lower margins. Just think of the German automotive industry, which has barely been able to bear increased energy costs arising out of the Ukraine war and now faces much steeper competition from Chinese automakers benefitting from government largesse and lower production costs.
Geopolitics also moves currencies. Oil shocks, for instance, tend to benefit oil-exporting countries as against the US dollar and oil-importing countries’ currencies. Major stimulus and investment programmes in advanced economies driven by geopolitics can move currencies as well. Witness the Inflation Reduction Act and how it boosted the US dollar. Meanwhile, the US-China rivalry has affected the ability of governments and international financial institutions to respond effectively to the sovereign debt crisis sweeping both developing and middle-income economies. China has become the world’s largest creditor and neither the West nor China wants to take a “haircut” to reduce governments’ debt burdens, which – if they get out of control – could prompt a wave of downgrades or even bankruptcies.
Finally, at a more structural level, the whole question of a shifting world order has direct financial impacts. The dominance of the US dollar as the world’s reserve currency is owed in no small part to the United States becoming the preeminent superpower after the Second World War and creating an international financial architecture supporting its hegemony.
The institutions created over the past 75 years – the World Bank, International Monetary Fund, the World Trade Organisation, and a thicket of preferential trade agreements – have supported a historically anomalous period of peace and prosperity.
But these institutions are creaking. They no longer reflect the multipolar world we live in nor the actual power – political, economic and military – of the countries that comprise the world order. Emerging powers are challenging the system, creating their own economic institutions, and even looking to create alternative reserve currencies.
So, a key long-term question – for many economies and currencies especially – is, “What will be the impact of this changing world order?” And a key short-term question is whether changes to that world order will come about peacefully or by force. (Historically, the dominant global power does not give up its pre-eminence without a fight…)
The answers to these and other geo-economic questions are extremely unclear but can only begin to be thought through properly by consistently tracking geopolitical developments and trying to understand what they mean.
That is, of course, what we are trying to help you do at Geopolitical Dispatch, with our daily analysis of geopolitical developments and their impacts on business and financial markets.
So, please continue to read our analysis and, if you like it, and think a friend or colleague might also, pass it on.
Michael Feller, Cameron Grant, and Damien Bruckard, co-authors
(Note: None of this constitutes investment advice, whether general or particular.)
Emailed each weekday at 5am Eastern (9am GMT), Daily Assessment gives you the strategic framing and situational awareness to stay ahead in a changing world.