financial markets

The Impact of Global and Regional Crises on Financial Market Volatility

Financial markets

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“Fear tends to manifest itself much more quickly than greed, so volatile markets tend to be on the downside. In up markets, volatility tends to gradually decline.”- Philip Roth

Even though the global economy started turning around in the second half of 2016, there has been a sharp rise in the global geopolitical instability. There are signals that the world’s economy is continuing to gain positive momentum. Overall, the financial markets continue to show forward growth and energy.

However, the sharp rise in global geopolitical uncertainty is a cause for concern. Not only because of the innocent people who end up caught in the crossfire but it causes short-term financial market volatility and runs the risk of causing longer-term economic instability and uncertainty.

Additionally, these conditions have the potential to affect the global overall macroeconomic outlook negatively. These adverse conditions then spill over into the world’s financial markets as they take their direction from the world-wide economic situation.

The impact of geopolitical instability on the world’s financial markets

Because of the nature of globalization and the way the Internet is structured, the world’s financial markets, especially the foreign exchange markets, are linked to each other both directly and indirectly. Therefore, positive as well as negative geopolitical and socioeconomic events from all over the world can have an impact on all of the global financial markets.

There are essentially two types of geopolitical crises that impact the world’s financial markets:

Global crises
The rising tensions between North Korea and the USA is a typical example of what happens when there is tension between the world’s global players. When asked for his opinion on the impact of the tension between the two countries, Armstrong Harris of Weiss Finance noted that global investors had moved their investments into safe-haven stocks such as gold and the Swiss Franc. Which, in turn, resulted in the fall in the value of the global financial markets by about $1 trillion (US).

Why are global investors so worried about whether North Korea will succeed in destabilising the region as well as launching their nuclear weapons at South Korea?

One of the reasons is the impact of the loss of South Korean income from the global GDP. Jim Randle from VOA News reports that the “South Korean economy accounts for around 1.9% of world GDP, and a severe drop in South Korean GDP … would have negative effects on key trade partners.”

Even though the probability that North Korea will use nuclear weapons against South Korea is tiny, the worst-case result will be the catastrophic destruction of the Korean peninsula. Thus, leading to a massive flight out of riskier investments into safe-haven stocks. Furthermore, the resulting humanitarian crisis will need cooperation from the world’s major role players such as the USA and EU, as well as China.

Regional crises
There is another geopolitical crisis that only impacts the affected regional financial markets. However, the impact of regional crises on the area’s capital markets can spill over into the rest of the world’s markets. Thus, turning a regional crisis into a global crisis.

A good example of this is the current India and China standoff over the fact that the Chinese military is constructing a road through the Doklam Plateau in the Himalayan region of Bhutan. The reports that this dispute began two months ago. However, experts such as Professor Steve Tsang, Director of the SOAS China Institute, don’t believe that it will escalate into a full-blown regional battle as “neither side wants a conflict at this point.”

The fact of the matter is that, while both Indian and Chinese forces are expected to hold their positions without allowing the situation to spiral out of control, it is an emotionally-charged issue on both sides. Mistakes happen, and events can very easily get out of control, resulting in a war that neither country can afford.

Even though this conflict is localised, it has the potential to harm the local financial market as well as spilling over into reducing the global capital market trading volumes and prices. This is primarily because the markets take their direction from each other.

For example, of the major bourses, the Tokyo stock exchange opens first, and the New York exchange begins last during a 24-hour period. Therefore, if Tokyo opens lower on the back of the bad news, there is a good chance that all of the following markets will open and close lower unless the reports change from negative to positive during the stated 24-hour period.

How To Make Smart Investments Without Being A Professional Trader

If you want to start investing in the financial markets, but are concerned that you aren’t knowledge enough about the markets and you think it might be better to pay a professional to handle your investments. Then let me assure you that you can make smart investments without needing to be a professional trader. You can do so by building a diversified investment portfolio using low-cost index tracker ETFs.p

What are ETFs?

ETF stands for exchange-traded fund. ETFs are similar to mutual funds in that investor’s money is pooled together to purchase a set of securities on behalf of investors, so that they own a diversified portfolio of securities when purchasing the ETF. Having said that, ETFs generally carry lower costs than mutual funds, as they are passively managed funds that usually track an index, such as the S&P500 or the MSCI Global Total Bond Index. Furthermore, ETFs are traded on exchanges and can be bought and sold as easily as stocks. This makes ETFs a liquid financial security, which means that you can easily liquidate your holdings should you want to invest in a different financial product or asset class.

Types of ETFs You Can Invest In

The ETF market has grown substantially over the last 10 years and you are currently able to invest in pretty much any asset class or underlying security imaginable using ETFs.

Popular ETFs are stock market index tracker ETFs that have a national stock index as an underlying, such as a FTSE100 ETF, if you want to invest in the UK stock market or a DAX30 ETF, if you want exposure to German equities, for example. While Bond ETFs such as High Yield Corporate Bond ETFs, European Emerging Markets Sovereign Bond ETFs, and Short-Term US Treasuries ETFs are examples of investment vehicles in the increasingly popular fixed income ETF space.

Alternatively, you could also invest in gold ETFs, if you want exposure to gold. If you have a look at the recent gold price changes, you will see that gold has rallied over 14% since the start of the year and has once again become a popular asset class, especially during difficult market conditions, as gold is seen as a safe haven asset. There are also ETFs that allow investors to gain exposure to all sorts of other commodities, real estate and loan portfolios.

cWhy ETFs are better than Mutual Funds

ETFs are the better investment tool than mutual funds for two main reasons. Firstly, ETFs generally carry substantially lower fees than actively managed mutual funds, as they are based on buy and hold strategies and, hence, incur less fund management costs. And secondly, research has shown that the majority of actively managed mutual funds don’t outperform their benchmark index. Therefore, you are better off investing in an index tracker ETF instead, as you will generate better returns and incur lower fees.

How To Build Your ETF Portfolio

Now that you know what asset classes you can gain exposure to using ETFs, it’s time for you to decide how risky you want your portfolio to be, how much you want to invest and what you want to invest in. If you are starting out with a relatively small amount of money like USD 3,000-USD 5,000 it is best to only invest in 3 or 4 ETFs to minimize trading costs (which eat into your profits).

A good example of a well-diversified ETF-based portfolio, with a medium risk level, would be to invest 50% in a US Stock ETF, 30% in a Global Corporate Bond ETF, 10% in a US Treasuries ETF and another 10% in a gold ETF. On the other hand, if you would prefer a very risky portfolio, you could put 50% in a US Stock ETF, 20% in an Emerging Markets Bond ETF, 20% in a High Yield Corporate Bond ETF and 10% in a US Treasuries ETF.

In terms of asset classes you can invest in using ETFs the riskiness level, in order of riskiest to safest is as follows: High Yield Corporate Bond ETFs, Emerging Markets ETFs, Developed Markets Stock ETFs, Commodity ETFs, High Grade Corporate Bond ETFs and Government Bond ETFs. The more portfolio weighting you put towards riskier ETFs, the more return you will generate, but, also, the more volatility you will see in the value of your investment portfolio.

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