Kambiz Kazemi, Chief Investment Officer
Cyclicality is a phenomenon widely present in nature and has an inherent beauty and universality. From the changing of the seasons to the cycle of life, the oscillating frequency of waves and systems in nature, cyclicality is present any which way we look.
In financial markets, cyclicality can be observed through seasonality in prices, in particular for commodities. In economics, periods of expansion and increased economic activity driving growth are followed by a slowdown of activity and recessions, resulting in the economic cycle.
The main characteristic of cyclicality is its length or periodicity. Generational changes are often associated with a 30-year cycle. There are four seasons every year and quarterly reporting of corporate results. Economic cycles, meanwhile, often range from a few years to a decade.
Societal phenomena and changes typically occur on a longer timescale, often over the course of a few decades. When it comes to major geopolitical changes – observed through cycles of wars, revolutions, regime changes or shifts of global power – cycles can range from half a century to a few centuries.
The Inquisition and Dark Ages followed by the Enlightenment, the rise of the Portuguese, Spanish or British empires and their subsequent decline are all examples of such cycles. More recently, the revolutions of the 1830s to 1850s, followed by WWI and WWII, were either a consequence or driver of a geopolitical cycle that led the world to a new setting.
As we approach the 600th day of the war in Ukraine following Russia’s unlawful invasion of the country, and we witness the heartbreaking events and worrisome developments in the Levant, there is a strong case to be made that we are in the midst of a major geopolitical cycle change.
The world came out of the horrors of WWII knowing that the only way to reduce the probability of future conflicts was by setting up a supranational entity, the United Nations (UN), and an international legal framework. World nations took similar cooperative steps with regard to the economy by establishing the World Bank and the International Monetary Fund. For the better part of five decades following the creation of the UN in 1945, this new global framework, despite its many flaws, managed to ensure some level of global harmony and accountability via an implicit acceptance of the rule of international law.
However, along the way, this framework eroded and was weak enough not to withstand the blow it was dealt in 2003 when the US under President Bush and the UK under Prime Minister Blair decided to invade Iraq without a mandate from the UN. One recalls France and Canada’s refusal to engage in such action on principle. It subsequently proved to have been wise, as no weapons of mass destruction (WMD) were ever unearthed in Iraq.
In our view, ever since two of the five permanent members of the UN Security Council did away with the need for international consensus to engage in or manage conflicts, a new cycle of geopolitics has been triggered. Other nations referred to the case of Iraq as a jurisprudence to engage in action ranging from pre-emptive strikes to no-fly zones and direct military interventions (e.g. in Libya).
We are and will continue to observe the continuous erosion of governance systems across the globe, be it by the proliferation of coup d’états (e.g. in Western Africa), gangs and criminal organizations taking over or challenging governments (e.g. Haiti, Guatemala, Ecuador, etc.) or the increasing success of the extreme right and populist politicians over the last two decades (e.g. Austria, Italy, Hungary, Russia, etc.).
In the absence of an asserted leadership by the main world powers with a (re)focus on a rule-based world order rather than haphazard crisis management and decisions driven by popular demand and polls, with no long-term strategic framework, we should expect the erosion of the system to continue at an ever faster and more worrisome pace.
Geopolitical risk, which many risk managers may have, in recent years or decades, relegated to the bottom of their list of concerns, should now be considered a serious risk and in the top five of any risk manager’s considerations, even though it is notoriously difficult to measure or predict.
To frame this risk, here are some lines of thought:
The challenge with these risks is that they are “known-unknowns”. We know that they will materialize but we do not know exactly how or when. Therefore, they are particularly difficult to hedge. Why? Hedging, like any investment strategy, must be viewed from a cost/benefit perspective, and in the case of geopolitical risks, the very high uncertainty on the timing would make any systematic hedging approach non-viable. Yet, all is not lost, a sound risk approach could include: a) a close monitoring of the global picture by relying on specialists and an in-depth study of history (i.e. macro is back), b) paying special attention to the portfolio’s geographic exposure and c) maintaining exposure to safe heaven assets (note; treasuries are not necessarily a safe haven asset) and an increased allocation to physical commodities.
Note: this note is too short to expand on the different notions and risks covered, for an in-depth discussion do not hesitate to reach out to us.
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