Financial Markets Face Fresh Wave of Political Uncertainty: ‘There’s Literally Nowhere to Hide’

The U.K. Parliament’s decision to postpone a final vote on the country’s exit from the European Union marks the latest geopolitical development likely to swing financial markets, highlighting the extreme levels of uncertainty that some investors worry isn’t being properly accounted for with U.S. stocks near all-time highs.

The U.S.-China trade war, Britain leaving the EU and impeachment proceedings in the U.S. are just some of the major political obstacles facing investors. Adding to the uncertainty are the Turkish military operation in Syria, attacks on Saudi oil production and social unrest spanning from Hong Kong to Barcelona.

In response, some investors are boosting holdings of cash and other assets that tend to hold their value when markets turn rocky. Others are recommending strategies that could protect against a swift downturn.

Investments that prioritize safety from volatility could become even more popular after Saturday’s vote by the U.K. Parliament, which potentially further extends a three-year-plus period of deep uncertainty. The vote forced the government to ask formally for another Brexit delay, although Prime Minister Boris Johnson urged EU leaders not to grant an extension, and his government said there was still time to leave, as planned, at the end of the month.

To capture just how much recent flare-ups around the world compare with previous levels of political upheaval, professors at Northwestern University, Stanford University and the University of Chicago created a variety of indexes that measure levels of global uncertainty.

One index, which captures a range of political and economic uncertainties, rose in August to its highest level on record in data that go back to 1997. It was even more extreme than after previous events such as the 9/11 terrorist attacks, the SARS outbreak in Hong Kong, the European debt crisis and the 2016 U.S. presidential election.

The most recent reading in September was the fourth highest on record.

“I think political uncertainty is clearly far higher than it has been for a long time,” said Nick Bloom, an economics professor at Stanford and one of the creators of the uncertainty indexes.

He said a “toxic combination” of low growth and rising income inequality has contributed to more extreme political uncertainty.

A separate index that focuses only on uncertainty in global trade policy has surged to around 100 so far this year. From 1996 through 2018, its average level was about 2.

“The number of political risks that could seriously move markets [is] as high as we have seen,” said Erik Knutzen, multiclass chief investment officer at Neuberger Berman, who has recently increased his holdings of cash.

At the same time, he said U.S. stocks are still likely to gain over the long haul—partly because the Fed still has much more room to cut interest rates than other major central banks have.

Mr. Knutzen has recently raised his exposure to U.S. small-capitalization companies to above his fund’s benchmark levels and raised his exposure to U.S. large-caps to equal the benchmark.

“It’s a view that the U.S. is the best-positioned economy of all the developed world economies,” he said. “It’s not exactly scintillating growth, but it’s much better than what we expect from Europe and Japan.”

While politics and trade have prompted swings in recent months, investors also remain focused on other key drivers of markets. Those include earnings for companies in the S&P 500, which are projected to post the biggest drop since 2016 in the third quarter, dulling some expectations for stock-market returns.

About 150 S&P companies will report results and conduct earnings calls in each of the next two weeks.

Bellwether companies including Microsoft Corp. , Inc., Procter & Gamble Co. and Boeing Co. are among the companies that are slated to report their results this week.

Large, multinational companies have been heavily affected by softening global growth and trade uncertainty, and rising correlations across asset classes have fueled fears that a reversal in momentum could drag down a range of investments at the same time. That trend played out late in 2018, another period when sentiment was fragile and news about trade policy and interest rates punished stocks around the world.

“In some ways, there’s literally nowhere to hide today,” said Michael Parker, director of research and head of strategy for Asia-Pacific at Bernstein Research in Hong Kong.

Instead of getting caught up in the gyrating political headlines, he said his firm recently devised a quantitative strategy that uses a variety of macroeconomic indicators to forecast market returns.

The model suggests a favorable scenario for stocks in Asia excluding Japan despite the political uncertainty, he said.

“While it would be professionally inadvisable to tell anyone to turn off the news, there’s other stuff going on that doesn’t always show up in the headlines,” Mr. Parker said.

One such political concern is the monthslong protests in Hong Kong.

Weiqi Zhu, who runs an equity fund at Gao Zheng Asset Management, said he sold all of his positions in local Hong Kong companies over the summer, including property developers and retailers, because of concern over how the antigovernment demonstrations and the heightened geopolitical risk with China will weigh specifically on those companies’ business models.

“The social unrest in the long run is going to impact these companies a lot,” said Mr. Zhu, who has also been holding higher-than-usual levels of cash.

Many investors have turned to haven investments and hedges involving futures and options in case volatility returns.

Esty Dwek, head of global market strategy at Natixis Investment Managers, said she favors gold and the Japanese yen given the ever-changing geopolitical backdrop.

“You’ve had to be ready to adjust your positioning more quickly than before,” she said. “We’ve tried not to trade every single development when the underlying economic backdrop is relatively supportive.”

By Steven Russolillo Updated Oct. 20, 2019 9:19 am ET


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