Summary
In 2017 global markets face grave geopolitical uncertainties.
Iran, North Korea, China, Russia and Syria could each pose serious risks to global stability.
Investors should evaluate the inclusion of gold and/or volatility exposure as potential portfolio hedges.
In our previous article, we reviewed five upcoming foreign elections that market participants should monitor. In this piece, our goal is to review the top five geopolitical uncertainties which could affect markets. As each of these situations on its own would seem to be significant and worth monitoring, the combined presence of all of these risks may give investors serious pause. With uncertainty seemingly being the only certainty that lies ahead, investors will need to consider the risks their portfolio may face and how best to hedge against these risks.
Iran
Iran has been formally PUT ON NOTICE for firing a ballistic missile.
- Donald Trump, February 2, 2017 via twitter.
The Iranian/U.S. relationship has never been one that would be described as "tremendous," but it has seemed destined for further tension following the U.S. presidential election. On the campaign trail, Trump repeatedly talked tough on Iran and vowed to renegotiate the 2015 Iran nuclear deal. The new administration has already faced a ballistic missile test from Iran and reacted with sanctions on 25 individuals and companies connected to Iran's ballistic missile program and those providing support to Iran's Islamic Revolutionary Guard Corps' Qods Force. In addition, Republican AND Democratic senators are considering additional sanctions on Iran. Chris Murphy (D-CT) stated:
There was nothing preventing Congress from imposing sanctions beyond those that were lifted as a result of the 2016 nuclear agreement with Iran.
With James Mattis, United States Defense Secretary, calling Iran "the single biggest state sponsor of terrorism in the world", it would not be surprising to see this administration seek considerable changes to the Iran nuclear deal. Bear in mind, this is an Iranian presidential election year. While current president Hassan Rouhani, a moderate, is expected to run again, the first announced candidate is Hamid Baghaie, former Vice President to hardline president Mahmoud Ahmadinejad. All these factors combine to produce a high potential level of instability coming out of Iran.
North Korea
Obviously North Korea is a big, big problem and we will deal with that very strongly.
- Donald Trump, February 13, 2017
Despite North Korea being prohibited from ballistic missile launches under UN Security Council resolutions, they chose to perform a test fire on the same day President Trump met with Japan Prime Minister, Shinzo Abe. This follows a busy 2016 in which, according to Jeffrey Lewis (the Director of the East Asia Nonproliferation Program at the Center for Nonproliferation Studies), North Korea's nuclear weapons program shifted from developing a nuclear capability in the abstract to deploying a nuclear-armed force of ballistic missiles. Mr. Lewis also proposes that, according to a new 3D model of North Korea's nuclear test site, many more may be on the way.
If Kim Jong Un's goal was attention, he certainly has it. China, North Korea's biggest trade partner, has banned imports of coal from North Korea. This is particularly notable since China is a vested party in North Korean stability, as it fears a potential refugee crisis if the Pyongyang regime suddenly collapses. In addition reports emerged that, for the first time in five years, talks were to kick off between former U.S. Officials and senior North Korean officials in New York City Washington DC. However, the Trump administration withdrew its initial approval of the North Koreans' visas necessary for this meeting only hours after the Malaysian government announced that VX nerve agent was used to assassinate Kim Jong Nam, the estranged brother of North Korean leader Kim Jong Un, on February 13 at Kuala Lumpur International Airport. Kim Jong Un has since reportedly executed five senior security agents with anti-aircraft guns. The U.S. has not released word on when or if the talks would be rescheduled.
China
We can't continue to allow China to rape our country, and that's what they're doing
- Donald Trump, May 1, 2016
The U.S./China relationship is turning into a long term chess match. In a recent call with President Xi Jinping, President Trump officially honored China's One-State policy, backing away from what he previously labeled as a potential bargaining chip. There is at least a small chance that China is now coordinating with the U.S. on North Korea following their most recent missile test.
While we believe these potential baby steps are going in the right direction there are the two major obstacles of trade and territory to be sorted out. During the campaign, President Trump advocated a 45% tariff on Chinese exports to the U.S., complaining that China manipulated the value of its currency. Kevin Lai of Daiwa Capital Markets, wrote such a tariff would lead to an 87% fall in China's exports to the U.S. China's overall exports would be expected to shrink at least 9% if such a tariff were imposed. There would also be significant suffering due to the collapse of businesses and job losses, with Lai estimating that China's gross domestic product could be trimmed by 4.8 percent.
Territorial disputes in the South China Sea continue to present further risks as well. The U.S. Navy began patrols in the South China Sea last week; in response, Beijing warned Washington against challenging its sovereignty in the South China Sea. This follows confirmation in December that weapon systems have been installed in all seven artificial islands China has built in the contested waters (despite a previous pledge to not militarize these islands). More recently, China has nearly finished building almost two dozen structures that appear designed to house long-range surface-to-air missiles. Trump's administration has called China's island building in the South China Sea illegal, and Southeast Asian countries understandably view this development as "unsettling."
Russia
Crimea was TAKEN by Russia during the Obama Administration. Was Obama too soft on Russia?
- Donald Trump, February 15, 2017 via twitter.
While the future relationship between Russia and the U.S. remains unclear, it appears to be clear that the Russian government is testing the new administration with aggressive military moves. Russia has secretly deployed a new cruise missile that American officials say violates a 1987 landmark arms treaty negotiated by Ronald Reagan and Mikhail Gorbachev. On February 10th, Navy destroyer USS Porter noted three "unsafe and unprofessional" encounters with Russian military aircraft while in the Black Sea. U.S. Defense Secretary James Mattis described Russia's general actions around the world as "aggressive" and "destabilizing." With a recent step up in violence in the Ukraine, NATO troops are increasing deployment to the eastern European border, a move Putin characterized as an effort at "provoking us constantly and are trying to draw us into confrontation."
Syria
These terrorists and their regional and worldwide networks must be eradicated from the face of the earth, a mission we will carry out with all freedom-loving partners.
- Donald Trump statement following Berlin attack, December 19, 2016.
In late January, President Trump gave the defense secretary, Jim Mattis, 30 days to develop a "preliminary plan" to defeat the Islamic State. With ISIS largely located within Iraq and Syria, there are more questions than answers at this point. With just over 5,000 U.S. troops in Iraq and small teams of special ops located in Syria, the biggest looming question is whether additional troops will need to be sent to these countries. Moreover, given that Syria President Assad is supported by both Russia and Iran, while Syrian rebel fighters have been backed by the U.S., Turkey, Qatar and Saudi Arabia, coordinated efforts to defeat ISIS may continue to prove challenging.
Honorable Mentions
Europe: European Union President Donald Tusk has expressed concern with a number of external faces challenging Europe, including the challenges with China, Russian and the Middle East noted above (as well as "worrying declarations by the new American administration"). In addition, Europe faces a number of pivotal elections in 2017, with some candidates calling for their countries to leave the EU.
Mexico: As of February 20, the Mexican Peso had already weakened by 10% since the U.S. presidential elections and continues to face further risks from pending U.S. trade policy. Proposals on renegotiating NAFTA, increasing border security, toughening immigration policy, and building a wall (that the Trump administration claims Mexico will pay for) may further increase political and economic instability in Mexico.
Investor Positioning
At this moment in history, investors may wish to evaluate how best to manage the impact of geopolitical risks on their portfolio. During uncertain times, an investor may consider a tactical allocation to gold and volatility. Empirical research shows that gold can exhibit both 'hedging' and 'safe haven' properties1, and volatility products can be uncorrelated with the stock market. REX ETFs may therefore be useful to investors as they continue to consider the certainly uncertain world that lies ahead.
Footnotes
- Baur, D. G., & Lucey, B. M. (2010). Is gold a hedge or a safe haven? An analysis of stocks, bonds and gold. Financial Review, 45(2), 217-229.
About REX
REX Shares, LLC ("REX") creates intelligently engineered alternatives ETFs that seek to help investors navigate turbulent markets and preserve wealth. REX was founded with a focus on gold and volatility based investment strategies. REX is based in Westport, CT.
Rex Shares Funds are distributed by SEI Investments Distribution Co. (One Freedom Valley Dr., Oaks, PA, 19456), which is not affiliated with Exchange Traded Concepts, LLC or any of its affiliates.
Carefully consider the Funds' investment objectives, risk factors, charges and expenses before investing. This and additional information can be found in the Funds' prospectus. Read the prospectus carefully before investing.
Investing involves risk, including the possible loss of principal. Click here for important additional risk information about REX ETFs.
