Geopolitical tensions are rising at an unfortunate time for President Biden as he tries to push through what would be the largest spending package in over 100 years. This ambitious domestic agenda is seemingly at risk due, in part, to foreign policy missteps. Most notably among them was last month’s dismount from the 20-year war in Afghanistan. Biden’s hasty departure from the country has opened up the playing field for state and non-state actors to jockey for legitimacy and control. In addition, Iran is reportedly dangerously close to developing enough nuclear fissile material to build a bomb. Lastly, China’s President Xi is trying to balance pro-growth objectives with “common prosperity.” His proposed solutions have spooked global financial markets. Biden is desperate to pass domestic spending legislation over the next few months, before 2022 mid-term election campaigning gets started in earnest. Investors hoping that this legislation will blunt the impact of a drop-off in stimulus payments may need to lower their expectations. All of this has created an environment similar to a multi-player chess match that would challenge even Beth Harmon of The Queen’s Gambit.
While Afghanistan’s humanitarian crisis gripped the headlines, most financial markets have continued to climb higher. The long-term instability in the region has kept its share of world GDP low and direct investment into the country negligible. The U.S. withdrawal creates an all-too-familiar power vacuum for the country as the Taliban seek legitimacy and money to lead a state that has been in conflict for much of modern history.
The messy exit damaged President Biden’s approval ratings. He has pledged to continue to pressure the Taliban into respecting the hard-fought rights of women and minorities in the region and fight for the continued evacuation of American citizens and allies. Time will tell how committed to these goals he is. His credibility may be dented if China or Russia replaces the U.S. by forming a strategic alliance with the Taliban. For investors, we recommend keeping an eye on the larger geopolitical picture rather than any singular crisis.
Many foreign policy experts believe that an Iran crisis is imminent. Israel proclaimed that Iran will have enough fissile material to build a nuclear bomb by mid-October. This crosses a red line outlined by four U.S. presidents. While Biden has shown a penchant for diplomacy over military action, he suggested that other options may be necessary to prevent Iran from gaining nuclear capability. For investors, any escalations in tensions could cause sharp spikes in oil prices over the near term. This would be an unwelcome development for the global economy, which is already struggling with elevated prices across many goods and services experiencing supply disruptions. Nevertheless, advances in alternative energy and an eager U.S. shale industry should keep a lid on oil prices longer-term.
China’s renewed focus on “common prosperity” is causing consternation amongst global investors. Some are arguing that recent regulatory changes are making China uninvestable. There is a certain irony to this accusation. China has been trying to reign in political favoritism for decades. Indeed, the World Bank estimates that corruption has fallen dramatically since the turn of the century as the leaders have sought to build credibility with foreign investors. In many ways, China is merely moving its market structure and regulatory framework on par with other developed markets.
Like many other countries, China is struggling with the dominance of a few giant technology firms, income inequality, and balancing environmental concerns with economic growth. It is also making structural changes to its labor force to get on par with established standards. For example, the country is eliminating the so-called “996” schedule, where firms expect worker productivity from 9 a.m. to 9 p.m., 6 days a week. However, China can execute much more quickly than many other economies. While legislation can take years in democracies, the Chinese Communist Party can adjust with the stroke of a pen.
While President Xi has thus far mainly focused on social issues, tax reform may be on the horizon. He is reportedly evaluating introducing capital gains and property taxes to raise revenue and reduce inequality. While these changes may be headwinds to growth, they are likely already reflected in today’s share prices. Regulatory change tends to create both winners and losers. We caution investors against drawing broad conclusions about the world’s second-largest economy. Instead, we believe it is prudent to invest in China through skilled stock selectors that can identify companies less exposed to regulatory interventions, thus delivering superior returns to clients.
These international issues can have domestic political impacts, especially as President Biden negotiates his economic package. Democrats have little margin for error now that the President’s approval rating has declined markedly. Recently, moderate Democratic Senator Joe Manchin called for a “strategic pause” in the budget process. As far back as the campaign trail, we suggested that Biden might have trouble convincing both progressives and moderates to sign off on his economic agenda. The next few weeks may be Biden’s greatest test. We suggest that, for investors who have significantly over or under-weighted specific sectors based on their expected legislative outcome, they return to a neutral stance.
Geopolitics is an important albeit unpredictable risk for portfolios. Clashes between nations are usually short-lived; however, an effective investment strategy must focus on the long-term, in our opinion. While each chess can provide valuable insight into the players, it is more important to keep perspective on the whole board.