The Top Down - How to Assess Geopolitical Conflicts

Transcript

Austin Fraser:

Hello everyone. My name is Austin Fraser from Fisher Investments Japan. And today we're gonna talk a little bit about regional complex and its impact on markets.

So there's been two separate events recently. One which I'm sure you've all heard of, was the attack by Israel on Iran with the express purpose of regime change and ending its nuclear program. Uh, the US of course, joined the fray bombing nuclear sites in Iran ,but there's a second event maybe that you didn't see or didn't pay as much attention to, and that was a conflict between India and Pakistan. Uh, started back in April when, uh, terrorists attacked, uh, Indian tourists in the administered regions of Kashmir, uh, and India and Pakistan had several retaliatory strikes against each other.

And so for most investors, you ask yourselves, well, what does this mean for markets? And of course, the general tendency at first is to react very negatively to these types of events. Of course, these types of conflicts are very tragic from a human perspective. It, it sort of pulls at our emotional heartstrings a bit. Uh, but we believe a more sober approach looking at the market impact is warranted.

And in particular what we want to do is look at the various outcomes and the probabilities of those outcomes. Because very much what we know is what we don't wanna invest on low probability events.

So the first step in this process is to really try to understand the background of these various actors. Uh, so in the case of Pakistan
and India, their two countries were created Uh, and they were partitioned into two different countries with two areas, Kashmir and Jammu that were bordering the two countries. And those were separated in a two distinct administrative zones of control, which separated those two administered regions. And the conflict between Indian Pakistan really deeply sits on religious grounds. So you have the Muslim majority, Pakistanis and the Hindu Majority Indians. And that has caused a number of conflicts over the years, uh, related to some of those religious disputes.

And then secondly, related to Iran and Israel, of course, we know Middle Eastern conflict is as old as time. And what this conflict in particular center is on is Iran's capabilities with nuclear weapons. And Israel is really trying to end that program as well as spur a regime change.
Now, the US is also involved in that because it also wants to end Iran's nuclear program, but here the threat is very existential, really for Israelis, this is probably the biggest threat you can think of for the West. Uh, having Iran get nuclear weapons is obviously something they want to avoid. And so it's a very deep, deep conflict that in our opinion, probably doesn't change in the decades ahead. You're simply gonna have, uh, a series of conflicts arise over time as these tensions escalate. But we really think it's important to take that history and then assess how it relates to markets. So the second step in this process is to really look at the historical record of conflicts and wars and determine what the market impact has been historically. And as much as these conflicts have a human cost and are very tragic in many ways, the market tends to look through these.

And so we can look at the table in the piece where we show historically, uh, major regional conflicts and wars and look at subsequent returns moving forward from that. And it's very clear the evidence shows that the market impact is pretty limited in the very short term. Maybe over the course of a few days, you may have a market reacting negatively based on sentiment reasons. But as you progress into the months and even a year ahead, markets are overwhelmingly positive. And so in many ways what we advise investors to do is look at this history, assess the market impact and the probability of markets being negatively impacted, which is mostly not likely to happen. And so we can move forward with an idea that this is a low probability event with a very low market impact. And thus it probably shouldn't dictate how we position portfolios moving forward.

And so why might this be the case? Why do we have these conflicts that are gathering headlines around the world, of course, causing people to fear nuclear war, things of that nature? It all lies down to scaling. And the idea that despite these being very populous regions, in particular with Pakistan and India, they have very small economies and particularly markets on a global scale. You know, for example, uh, with Indian Pakistan in the M-S-C-I-L Country World Index, which includes emerging markets in the broader globe, the Pakistani stocks are not included in that index. They're too small, and the Indian market represents less than 2%. So if you have a regional conflict that's really going to impact two countries, it probably isn't gonna have a big impact on the broader holistic marketplace. And thus, while we shouldn't ignore these conflicts, we shouldn't take it to an extreme and expect some sort of global recession that causes a bear market. Most investors would then say, what if these regional conflicts expand to include larger world powers, in particular with Pakistan and India? You might have something like the US and China because Pakistanis are largely supported by Chinese, where Indians are largely supported by the United States. And so if you get a conflict where it brings in these outer actors, wouldn't that be enough to cause a global recession and perhaps a bear market? And the answer is yes, of course. But we need to be careful here with assessing the probabilities of such an outcome. There are a lot of geopolitical drivers that pose an impediment to these types of broader regional conflicts, of course, into a global conflict. And we just simply see that as an incredibly low probability. You've only seen it really once in modern history going back to World War II. And so while we don't want to completely discount that happening, we need to say, well, it's a low probability event and we probably don't wanna make investment decisions based on that very low probability event.

So in conclusion, we have had a number of events recently where geopolitical conflict has come into investor attention and it's garnered lots of headlines. It's caused lots of fear factors, lots of negative press, uh, stories, uh, but we think it's very important that you focus instead on the probability of that outcome as well as the market impact. And in some cases, we can see that the probability is quite low, like a global conflict that leads to a bear market. In other cases, like these more regional conflicts, they're likely to continue to occur. But we notice that the market impact is relatively minimal now, in both cases, a low probability event and a minimal market impact event. We don't wanna make investment decisions based on that.

Thank you all for listening today. I hope you enjoy this content.
Please take a look at the piece attached for further details.