Geopolitical uncertainty and your investments: What to consider now

Geopolitical conflicts are happening in various parts of the world, and there are concerns that they could expand or that new ones could begin. The Federal Reserve has hiked interest rates at record speed and the tension of the 2024 presidential campaign is only starting to escalate. Meanwhile, Wells Fargo Investment Institute believes the U.S. economy will weaken further in 2024.

With all this uncertainty, here are five portfolio considerations to help you be smart about the markets.

1. Put it in perspective.

History tells us that the markets move in response to major geopolitical events but that the impact tends to be short-lived. Since World War II, the S&P 500 Index has responded to new cross-border conflicts and acts of terror by falling an average of approximately 4% in the roughly two weeks following the incident and then recovering in about a month.1

In 2023, markets have been largely looking past geopolitical turmoil. Measures of market volatility, such as the Chicago Board Option Exchange (CBOE) Volatility Index (VIX), which we would expect to rise in times like these, have largely remained below long-term historical averages.2

We believe that global capital markets do evaluate global conflicts but consider serious escalation as unlikely. It’s a good reminder to weigh both the scenarios and their likely probabilities. And there are steps investors can take now, even if conflict worsens.

2. Have a plan and stick to it.

How I favor managing today’s geopolitical risk and uncertainty is not a lot different than during any other period: Have a diversified strategic asset allocation that’s built around your risk tolerance and long-term objectives, and stick to it. Beyond that, I think it’s important for investors to know the answers to two questions: How much of a drawdown can you stand, and how much liquidity do you need? When markets do pull back significantly, your portfolio should be designed to help ensure that you can manage your emotions through to the other side and that you have enough easily accessible funds to maintain your lifestyle during the downturn.

Periodically review your plan, especially if your circumstances change or with significant life events. Consider rebalancing often to reset your portfolio allocations to align with your long-term goals if they stray over time.

3. Manage your emotions.

Emotional reactions can lead to decisions that pull you away from your plan and negatively impact your returns. They can tempt you to try to time the market. It may feel good to say, “Things don’t look good, and I’m pulling out of stocks.” But, historically, that reaction has been highly unlikely to help achieve long-term goals.

Here’s why: Over the past 30 years, if an S&P 500 Index investor missed out on the index’s best 10 days, their returns would be 35% lower than a buy-and-hold peer. Miss the best 20 days, and you’d have lost nearly 60%.3 There’s always going to be something scary or uncomfortable going on in the markets or the economy.

4. Consider these tactical adjustments.

Your long-term strategic allocations will likely drive the majority of your returns over time. However, I believe you can improve your chances for better risk-adjusted returns through tactical asset allocation, or short-term adjustments based on expected relative performance.

The key word to keep in mind in our current investment environment is quality. Wells Fargo Investment Institute is bullish on high-quality U.S. large-cap stocks and U.S. investment-grade bonds, especially on the longer and shorter ends of the curve. It’s also why we hold a more unfavorable view of U.S. small-cap and emerging market equities.

If you’re a qualified investor, you may want to consider alternative investments to help diversify your portfolio. For example, private capital is designed to be well-suited to more difficult periods in the economic cycle, as is private equity. On the public equity side, it’s hard for companies to access capital amid high interest rates and debt levels. Private equity offers an opportunity to take advantage of that. Rather than investing in a company and hoping management can figure a way through the challenges they face, you can invest from the other side, strategically helping companies get out of difficult situations.

You also may want to consider a broad-based commodity exposure. Saudi Arabia and Iraq still provide roughly 20% of U.S. oil. Meanwhile, despite sanctions, Russia remains a key global supplier of grains, industrial metals, fertilizer, and energy.4 A modest commodity allocation could at least partially diversify against financial market price declines stemming from commodity price inflation if war in the Middle East limits oil export routes or if Russia takes more Ukrainian territory.

5. Talk to your advisor.

Every investor’s situation is different, so consider meeting with your advisor. You might discuss your plan and explore potential reasons to change it. You might find out how to diversify with alternatives or real assets, such as real estate or commodities.

In times like these, advisors can help you find emotional balance. They can play a very strong role, like a therapist, helping ensure that your behavior and emotions don’t get in the way of your portfolio. In other words, they can help you be smart about the markets.

 

Sources:
1. “Why Markets Are Relatively Calm in the Geopolitical Storm,” Financial Times, October 2023
2. “Investors Are Unprepared for Stock Shocks, Wells Fargo Strategist Warns,” Yahoo Finance, December 2023
3. “The Perils of Trying to Time Volatile Markets,” Wells Fargo Investment Institute, September 2022
4. “Oil and Petroleum Products Explained: Where Our Oil Comes From,” U.S. Energy Information Administration, December 2023; “What Else Does Russia Export, Beyond Oil and Gas?” World Economic Forum, March 2022