Friday, February 24, 2017

Geopolitical Black Swans Are The Stock Market’s Biggest Risk

Trump’s unpredictability and eagerness to upset the apple cart raise the chance of a crisis-induced swoon.


By Howard Gold
MarketWatch
February 24, 2017

The S&P 500 index is up almost 10% since Election Day, as the Trump rally rolls on.

I think this is a continuation of the stock market’s SPX, +0.04% bull run that began in March 2009, but this time, as I’ve written, the catalyst is political: the prospects that a Trump Administration will cut regulations and taxes and stimulate the economy with a big infrastructure program.

How much of that will Congress pass? Who knows? But with earnings growth resuming and investors already factoring in three hikes in the federal funds rate this year, only a sudden burst of inflation or the prospects of recession could derail this market. I don’t expect either.

What’s more likely is heightened geopolitical risk, the proverbial black swan, and here I think President Trump’s unpredictability and eagerness to upset the apple cart, especially internationally, raise the chance of a crisis-induced market swoon.

Consider what’s happened recently:

Three Russian fighter jets buzzed a U.S. destroyer in the Black Sea for several hours earlier this month while the vessel was conducting “routine operations in international waters,” a U.S. official told Fox News.

•A Russian spy ship was spotted in international waters 70 miles off the coast of Delaware

Russia declared it would not return Crimea, which it annexed after an invasion of the eastern Ukrainian region, nor would it even discuss the matter.

•Most seriously, Russia has deployed new ground-launched cruise missiles, in violation of the Intermediate-Range Nuclear Forces Treaty, signed in 1987 by President Ronald Reagan and Soviet leader Mikhail Gorbachev. The new system could “substantially increase the military threat to NATO nations,” The New York Times reported.

North Korea tested a new medium-range ballistic missile, likely capable of reaching South Korea and Japan but not the continental United States. North Korea says it has conducted five successful nuclear-weapons tests since 2006. Underscoring the regime’s ruthlessness, the half-brother of dictator Kim Jong Un was assassinated in Malaysia, and one of the suspects works at the North Korean embassy.

•In January, Iran, too, tested a medium-range ballistic missile, which the U.S. said was in violation of U.N. resolutions. In response, the Trump administration slapped additional sanctions on Iran.

These don’t include other potential hot spots like the islands China claims in the South China Sea or the Sunni Arab Middle East, the cauldron that never stops boiling over.

The Russian situation is most complicated because of continuing investigations into alleged contacts between the Trump campaign and Russian officials in the months before the presidential election. Retired Lt. General Michael Flynn was fired as the president’s national security adviser following reports he had talked with the Russian ambassador to the U.S. both before and after Trump’s election and had misled Trump officials about the extent of those contacts.

Trump has repeatedly stated he wants good relations with Russia, and hasn’t had a bad word to say about autocratic President Vladimir Putin. But at his press conference last week, he acknowledged the investigations have complicated his efforts.

“I think Putin probably assumes that he can’t make a deal with me anymore because politically it would be unpopular,” the president said. “Because look, it would be much easier for me to be tough on Russia, but then we’re not going to make a deal.”

Robert Legvold, a professor emeritus at Columbia University, said Russian-U.S. relations are very complicated, even under an administration that has been as friendly as this one has.

Legvold, whose book “Return to Cold War” appeared in paperback last year, said Russia’s annexation of Crimea marked the beginning of a new Cold War between Russia and the West.

“It’s fundamentally different from the original Cold War, but it does have characteristics that are similar to the early years of the Cold War,” he told me in a telephone interview. “What Putin is determined to do is overthrow what he calls the post-Cold War order” in which the dominant superpower U.S. essentially called the shots.

Now, Russia and China are aggressively asserting their interests, often in defiance of the U.S., and so are rogue states like Iran and North Korea, both favorite Trump targets.

Iran, of course, lies right by the Strait of Hormuz, the chokepoint through which 20% of the world’s traded oil moves. And North Korea’s belligerent, paranoid regime has nukes and missiles that can reach South Korea and probably Japan.

“I am deeply concerned about the failure of major powers to figure out ways to move forward in serious ways—for example, North Korea,” said Legvold. “The major powers are not doing what they need to do.”

That “every man for himself” environment makes it easier for a crisis to get out of hand.

“The second you get any of this foreshadowed, even before it begins happening it’s going to affect markets,” said Legvold.

That’s why I see geopolitical black swans, which by definition can’t be predicted, as the biggest risks to the market today.


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