How Do Geopolitics Influence Financial Markets?

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When it comes to the global financial markets, there are numerous factors that impact on daily price fluctuations and valuations.

From supply and demand to macroeconomic factors such as inflation and the base interest rates to geopolitics, these elements can combine to have a direct impact on prices and influence the decisions made by investors across the board.

But what geopolitical factors impact on the stock market, and how can you quantify such risks and react as an investor?

The Geopolitical Factors That Affect the Stock Market 

Ultimately, geopolitical factors are like beta drivers for the stock market, which means that due to mixed effects of currency and equity, performance could well increase volatility in the financial marketplace.

These differ from macroeconomic factors such as inflation, as they describe globally prevalent macros that affect the marketplace as a whole.

Some of these universal factors include a company’s revenue or earnings, which impact daily stock prices on an hourly basis. The real-time global GDP is also critical, with a growing gross domestic product central to the health of stock market returns over the medium and longer-term.

The currency valuations observed through a desktop trading platform also represent an important geopolitical factor, with so-called “competitive” devaluations known to trigger cascading sell-offs over time.

Of course, the last 18 months have been largely unprecedented as a result of the coronavirus pandemic, creating a number of unique adverse geopolitical factors that have impacted on stocks. Take long Covid and fragile global supply chains, which are impacting directly on long-term and real-time productivity and placing the future of some equities at risk.

At the same time, the rumblings between China and the West (and particularly the US) continues to send geopolitical shockwaves throughout the global stock market, even following the election of Joe Biden and the removal of the increasingly protectionist Donald Trump.

China and Russia are also thought to have deliberately sowed the seeds of disunity in Europe, further undermining the markets and the value of individual stocks.

How to Respond as an Investor?

Ultimately, geopolitical risks tend to trigger increased risk-aversion among investors, usually by negatively impacting stock market returns across all developed economies.

At the same time, two-year US Treasury yields also decline, which is important given that many investors look to combine equities and fixed-income products such as bonds as part of a wider investment portfolio.

Interestingly, capital inflows are similarly affected, with reduced flows into emerging markets and increased flows into developed economies.

With the price of commodities such as oil found to weaken in response to increased geopolitical risk (such as those listed above), the key takeaway here is that even investors with a broad and diverse portfolio (which includes stocks) are likely to see their returns decline during times of geopolitical tumult, consistent with a reduction in economic activity.

Of course, some financial markets and asset classes are more affected by geopolitical threats than actual events (such as the start of wars or imposition of sanctions), including the stock market and individual indices across the globe.