Do Markets Swing Along Political or Economic Events?: Part 2

Economic EventsThe “End of History?” Geopolitical Risk is Higher Now Than During Cold War

France and Italy, two pillars of the European Union (EU), are facing constitutional changes and/or elections, which could bring more anti-EU sentiment to the forefront. If either one of these two countries pulls out of the EU, it would cause a collapse of the entire EU project.

Without Italy, most of southern Europe would follow to the exits. The political debate in Italy will be sharp. Italy’s Prime Minister Matteo Renzi has launched significant reform projects to increase economic competitiveness. But this marks a huge political gamble on his part. He will face populists and leftists and, therefore, he could lose his pro-EU majority.

In France, Europe is a topic among the rising voice of extremists who want out.

Then there is the risk of the central banks. Since the beginning of the 2008 financial crisis, the global central banks have prevented the Western economic system from collapsing. Blame—or praise—them as loud as you want, but the U.S. Federal Reserve, the Bank of England and the European Central Bank have bought back the debts that the world contracted in the pre-subprime crisis years.

Now these same banks have come to the final stop of their appeasing policies. Interest rates are now at zero, or not much higher. The systems have stalled and the central bankers have totally detached themselves from an economic calculus. They are operating almost entirely to manage the political circumstances.

At the recent G20 summit in China, Chinese President Xi Jinping stressed the need to prevent the return of protectionism. He urged the development of world trade to boost economic growth. Yet the world leaders ignored this call, instead focusing on political problems related to Ukraine, Syria, and terrorism. The latter two issues provided an opportunity for the Kremlin and the White House to quarrel some more. Russia and the U.S. have reached a tenuous agreement for a brief ceasefire, but that’s only a pause in the Syrian conflict, in which their desired outcomes differ widely.

Such is the context, and defense stocks represent the best way to confront the many and complex risks that exist.

A few days ago, I was reflecting on the fact that every decade has brought major geopolitical changes, which have also altered the global economic landscape. The 1950s saw the rise of the Cold War. In the 1960s, we had the end of colonization in Africa and the roots of economic nationalism and resource nationalization, which led to the end of cheap natural resources. In the 1970s, Islamism took shape and the decade ended with the U.S. losing a key ally in the Middle East: Iran. The 1980s brought us the erosion of communism, leading up to the 1990s with the reshaping of Eastern Europe in the geopolitics of the post-Berlin Wall era.

Some scholars, like Francis Fukuyama, called that period the “End of History,” but they spoke too soon. Just a few days ago, the world marked the 15th anniversary of the September 11, 2001 attacks that brought down the World Trade Center in New York City and breached the wall of the Pentagon in Arlington County, Virginia. By the end of the first decade of the 2000s, several Middle Eastern countries were reshaped, but Russo-American relations were destined to worsen. Today, Moscow and Washington are barely talking.

The Middle East is a disaster and a wave of migration to Europe has brought back the far right there. What will the world look like in 2020? Which countries will fall? In 1978, U.S. president Jimmy Carter described Iran as a solid and reliable ally. Months later, Iran fell to a band of clerics and students who dared to invade the American Embassy, making a mockery of U.S. power. It wasn’t Carter’s fault though. Like many, he could not have foreseen such risks, which are always lurking. Author Nicholas Nassim Taleb calls such situations “Black Swan” events.

In financial market terms, you can’t go wrong with defense. People have been making weapons since the first days of human societies. Weapons have been a major source of technological innovation. Even the peaceful Internet first saw the light of day as a military project, as did jet engines, drones, radar, GPS, and a countless number of other civilian products.