If you were to look only at the stock market and nothing else, you’d probably have no clue that we are still in the worst economic crisis in decades due to a global coronavirus pandemic. After all, millions of people just lost their jobs and hundreds of global companies are filing bankruptcies. Buy why do the stock markets ignore all the bad news and keep on going up?
Are we still heading into a recession? How will this euphoria end up? To understand these questions, you need to realize that geopolitics plays a major role today in the investing world and it will continue to affect your investment returns in the years to come.
What do I mean by geopolitical risk?
Geopolitical risks refer to a wide range of issues, from rising populism to the US-China trade war, from Brexit to Hong Kong protests. It occurs when there is a threat to the normal relationships between or within countries and regions in terms of politics, economics or the military.
Geopolitical risks create uncertainty for sure and it affects the financial market. But people often overlook the fact that the root of most geopolitical risks is caused by the financial market itself.
Most human activities can be explained in finance: you are either creating wealth or redistributing wealth. – Ivan Guan.
Are the Wall Street legends fools?
Recently, the doomsayers have been extremely quiet. The wall street legends including Ray Dalio, Warren Buffett, Stan Druckenmiller, David Tepper, Carl Icahn, Paul Tudor Jones, and Bill Miller all seem to be on the wrong side of the markets.
The historical rally of the global stock market has made them look like fools. The “dumb money”, as they call the retail investors, is looking a lot smarter in the never-ending stock market rally.
Why does the stock market act as if COVID-19 has never happened? Who is bluffing? Or are we missing something?
Some people say the market is “forward-looking” and prepare for the re-opening of the economy. I would have agreed with you in Feb, but it sounds farfetched to me now.
If you read my article in February, I was never really concerned about the economic damage by COVID-19 itself. Most pandemics are non-events to the financial markets.
But now the situation is rather different. Many “unprecedented events” have happened in the past 3 months.
- From circuit breaker to zero interest rate and unlimited Quantitative Easing
- From the oil crisis to negative oil prices;
- From China passing a national security law to the US national protests following the death of George Floyd
If you look at the chart, the S&P 500 index has reached almost the pre-crisis level. Are you saying that with the months of global lockdown, bankruptcies of companies, disruption of supply chains and uncertain future, the world is in a better place? You are kidding yourself.
The market is still driven by smart money, just not the way you think
In one of my articles in March, I explained the three waves of the market crash. You can see that the market was completely rational at that time. It was just reflecting what was happening.
The stock market always goes up and down for a reason. If you cannot figure it out, it is best to stay away from it. That is what the “smart money” does sometimes. Because we may not know a lot of things until they have happened.
I will explain the 4 waves of the recent market rally, using the S&P 500 chart below as an example.
- Wave #1: Liquidity Returns: When the market bottomed on March 23, those who had suffered margin calls have paid their losses. With US Fed announcing their “unlimited” quantitative easing, liquidity went back to all markets, stocks and bonds.
- Wave #2: Tech & healthcare boost – With global government lockdown. The companies involved in our digital life became the market darlings. There was a rush to purchase the big tech companies. There were also speculations of some healthcare companies who may benefit from the pandemic.
- Wave #3 & Wave #4: I will talk about this later.
If you really zoom into the details, you will realize that from wave #1 to wave #2, the rally was driven by tech companies, healthcare and supermarkets. This makes sense as they are not only resilient in such a situation, but also the potential beneficiaries.
And incidentally, since tech companies and healthcare companies are heavily weighted in the index, a few stocks can move the entire index. In fact, just the 5 tech companies alone, Apple, Microsoft, Alphabet, Amazon and Facebook already account for nearly 18% of the S&P 500. So it was not a broad market recovery, it was just a tech & healthcare companies recovery. Most companies’ shares are still lying on the ground (until Mid-May).
But when wave #3 started, things started getting fishy. Just before the market was heading south in mid-May, there was a wave of companies announcing their vaccine development. “Vaccine is imminent” became the most commonly heard news for a couple of weeks. But these were “hypes” because while these companies were announcing that a “vaccine is imminent”, many senior management officials were eager to offload their company’s shares. Below is an example of a company that had a “promising result” of a COVID-19 Vaccine, yet their senior executives were dumping their shares like there was no tomorrow. (Every red person in the chart represents a significant open market sell).
Wave #4 is even more mysterious. With the escalation of US-China tensions and nationwide riots in the US, the US market rallied this week at an even faster speed. But this time, it was no longer tech or healthcare stories, but the mighty American industries led by Boeing, which shot up 40% in just 3 days! Why?
Some people say the market expects a recovery of the airline industry. That is BS to me. Let’s just ignore that Warren Buffett has ditched the US airlines and sold all his shares, a 40% price means Boeing is valued $46 billion dollars more in 3 days. Does that sound plausible to you?
I couldn’t figure this out until I saw the news that Taiwan’s former presidential candidate Han Kuo-yu was removed as Kaohsiung mayor. Everything starts to make sense.
You can’t win in investing without understanding the politics
I am not here to talk about politics, but without understanding it, you are often on the wrong side of the market.
Let me start with Hong Kong (we will come back to Taiwan later). We all know that Hong Kong people have been protesting since last year. As I pointed it out in this article, it is hard for an English only reader to see the events clearly because the information you receive is always biased. Our world view is shaped in a confined paradigm through decades of brainwashing by the media we receive. Unless you actively seek alternative views, it is hard for you to have a balanced view.
Suggested reading: How to invest amid the US-China trade war as an Asian investor.
We know that Hong Kong people have been protesting since last year. Was it used as leverage by the US for the US-China Trade War? I think we should be clear about it by now.
China recently passed a National Security Law and on May 27, US President Donald Trump said he would announce “a strong response to China’s planned national security legislation for Hong Kong and it would be announced before the end of the week.”
The English media has portrayed it as “the end of Hong Kong”, and countries are talking about taking Hong Kong “refugees” and capital is said to be flying out of Hong Kong.
Let me show you the Hong Kong stock market chart after the announcement.
Does this look like the “end of Hong Kong”? The next thing we know is that “Hong Kong’s protest movement is running out of cash”. How ironic. Where is the “support”?
And if you think capital is leaving Hong Kong, you should check out the share price of Hong Kong Exchange (0388.HK).
Talk is cheap, money is real
Let me give you another example. On June 3, the Prime Minister of the UK Boris Johnson offered 3 million Hong Kong residents British citizenship. But the next day, two of the largest British banks, HSBC and Standard Chartered Bank defied the UK and openly endorsed the Hong Kong security law.
So if you interpreted the news at its face value and took an investment position, you may suffer a great loss. The market is always right, but it may not be how you understand it.
What will be the next geopolitical move?
So now let’s go back to Taiwan. If Donald Trump has lost the Hong Kong card, what else can he use to play against China? It is obviously Taiwan, the “trump card”.
I talked about why the US stock market always rises no matter how messy the rest of the world is through three strategic positions:
- The US Dollar
- The US Technology
- The US Military
Additional Reading: Why did the stock market rally despite the looming recession?
Taiwan has two strategic uses, technology and military bases.
Taiwan has been a long term loyal customer of US arms including fighter aircraft, tanks, and missiles. Since 2008, the United States has sold more than $24 billion in arms sales to Taiwan. But do you know Donald Trump has sold Taiwan $10 billion in arms sales in 2019 alone? Just last week, Taiwan announced it was buying land-based Boeing-made Harpoon anti-ship missiles. In case you are not aware, Boeing does not just build commercial airline, it has almost half of its revenue from selling defence arms.
So this saved Boeing, gave a boost to the Dow Jones Industrial Index, and created more tension between China and Taiwan, how brilliant.
But the strange thing is that it seems that the market has already known, 3 days in advance, the defeat of the KMT. Why?
How does this affect you?
You may think, this is none of our business if I am not buying these shares. Really?
Thanks to Donald Trump, we are living in a world more divided than ever since World War II. If you agree that Asia’s geopolitical conflicts are not coincidental, you should know our small red dot is not immune to what is happening around us.
The market did not rally because “a market always goes up after every crash”. The reality is that many companies will just disappear from history. Investing for the long term is more dangerous than you think.
The “smart money” may look foolish to you today, but you need to understand that Wall Street is formed by a group of the smartest people on earth. And I wouldn’t bet against the collective wisdom of these people.
Investing is not just about technical signals or understanding some jargons in the financial statements. I have seen many “investment gurus” come and go, but the smart money is always here to stay. Because successful investing is not about making the right decision once or twice, but being the last person who stands on the battlefield. You can strike a roulette or even a lottery, but that doesn’t make you a lifetime millionaire.
And to do so, your focus needs to be on the right side of the macro-political and economic trend, not the daily market ups and downs.
Let me help you pull everything together
I want to let you know that the stock market always moves for a reason. Sometimes we can rationalize it, but most of the time, we can only understand it after a long time or we can never know why.
Geopolitical risks exist as a real threat to your wealth, but if you spend time and effort to understand it, it can offer rare opportunities.
There is no need to argue who is right or who is wrong; who is smarter or who is braver. You can make money even if you are wrong and you can still lose money even if you are right.
Whatever is happening in the global market, stocks, bonds, commodities and currencies are affected by the capital behind them. Don’t just look at the index number and say the market is going up or down. You need to understand the political and financial powers are behind it. Ask yourself: what is happening to the US dollar? What is happening to the bond market? What is happening to the price of gold, oil and soybeans?
To survive in investing, you need to have fear of the market. There are many market participants trying to fool you so they can either offload the shares to you by creating hypes or instilling fear so they can buy from you at a bargain. The global wealth reshuffling process has just started, it is not over yet.
The stock market may seem to deviate from its economic fundamentals now, but it is perfectly aligned with the geopolitical directions.
The market is always efficient, but it doesn’t mean it cannot be manipulated. What if the one who is manipulating the market is not just some traders or even hedge funds, but bigger boys to suit the political agenda behind it? By pulling component stocks in the key indices, the whole market is dragged along. When the rule-maker becomes a player, how do you want to play the game?
What do you think is the next biggest geopolitical move that will impact the financial market most? Leave your comments below and let’s discuss.
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I’d think the next biggest geopolitical move that will impact the financial market most is Biden becoming president…or maybe even Trump continuing to be president :/
I agree with you. That will have a great impact.
Appreciate Ivan for sharing your insight in this article.
With the unleashing of trillions of liquidity by the Fed / Trump administration and central banks worldwide, much would probably into stock markets. Will this massive liquidity lift up stock, property and physical asset prices at least in the short to medium term.
If so, how can we as investors better mitigate / leverage on this.
Hi, HJ Tan,
The massive liquidity has already worked its wonders in the short term, but the challenge we face is that we do not know what the central banks are thinking. As I mentioned in the article, the rule-makers are the players now and we are at the mercy of their actions.
My advice is to avoid leveraged positions and stay diversified and nimble. You should also stay away from “crowded” trades because there will be a time when everyone is running out of the door at the same time when fire starts.