IN A NUTSHELL: Geopolitical events are major incidents happening across the globe that affect economies and the value of investments. Understanding these events will help trustees make smart investment choices for their retirement fund.
Geopolitical events can significantly influence asset prices, with their impact varying depending on where these events occur geographically. No two geopolitical events are the same; however, various ones can coincide.
These events could include civil unrest, the disruption of sea routes by pirates or rebels, invasions of other nations, elections, international sanctions and trade wars.
Let’s take Russia’s invasion of Ukraine as an example. Both countries are large exporters of grains (sunflower, maize and wheat) to other countries that can’t grow these crops in sufficient quantities to feed their populations, such as Egypt. Russia’s invasion meant grain production and shipments to Egypt dropped significantly. This shortage in supply coupled with high demand led to the world price of wheat rising dramatically.
Egypt imports the bulk of its wheat to feed its 123 million people and pays for it in dollars. Suddenly, the country had to pay much more for wheat and ran out of dollars. To keep the value of the Egyptian pound unchanged the government made some tough decisions, leading to a spike in domestic inflation.
Eventually, the Egyptian government yielded and allowed the pound to trade freely on the currency markets. In one afternoon, the price of Egyptian listed shares and bonds lost around 75% of their value in dollar terms. In addition to losing its buying power on the international markets, the pound’s purchasing power was already eroded by inflation.
Why did the government try to keep the value of the Egyptian pound stable against the dollar?
If they can’t maintain the currency’s value, the pound becomes less valuable compared to the dollar. This makes everything Egypt imports (like wheat) more expensive, leading to higher prices for goods and services in Egypt.
Locally, political events have also strained the value of South African assets – from listed companies that earn the bulk of their revenue in the country to government-issued bonds. Bad government policy decisions and large-scale corruption – as exposed by the Zondo Commission on State Capture – weighed down on investors’ sentiment towards South African assets. They opted rather to buy foreign assets than risk their money in domestic shares and bonds.
This led to a weakening of the rand, where foreigners dumped South African shares and bonds, sold rands and bought dollars to move their investments offshore. The sell-off in government bonds, which led to a slump in bond prices, affected government finances significantly. The government had to borrow at ever-increasing interest rates to fund the gap between tax takings and public spending. At the same time, local businesses were wary of investing in their operations and employing more people, leading to a stagnant job market and tepid economic growth.
When a geopolitical event plays out positively, like a peace deal in case of war, the resumption of trade on sea routes, stable governments after an election, or pacifying civil uprisings, investors tend to reduce the risk premium they’ve attached to a country and start investing again, leading to improved markets.
What happens on the global stage directly affects the valuation of South African shares and bonds. The country is a small, open economy and investors’ money can flow in or out of it easily.
Trustees should keep abreast of what is happening in the rest of the world and study the linkages between political events and the eventual impact on their fund’s portfolio.
In this way, trustees fulfil their primary role: the long-term security of their beneficiaries’ retirement savings.
Learn more
The impact of geopolitics on your retirement fund
Sources
Institute for the Study of War
State Street Global Advisors: How Does Geopolitics Affect Financial Markets?
