Before investing in emerging markets, think about how you’ll handle short-term political volatility. After all, it’s a common hurdle in that space, says Michael Reynal, chief investment officer and portfolio manager at Des Moines, Iowa-based Sophus Capital, which sub-advises the Renaissance Emerging Markets Fund.
Think about the reaction by the White House to the potential for North Korea to get nuclear weapons, and its subsequent move to pressure China to help prevent the proliferation of such weapons. While “this is a long-standing story,” Reynal explains – the U.S. has been pressuring China to help with North Korea for several decades – “what [President Donald Trump] has done is accelerate that pressure,” and that has weighed on global markets.
Despite being pushed by the U.S., China has continued to stand back regarding North Korea. As Business Insider reports, one possible result is further deterioration of U.S.-China relations going into the fall.
Reynal isn’t convinced the White House’s plan will pan out, so he’s sticking to monitoring the situation and how it unfolds. “I’m not sure [Trump’s plan] will work […] He is saying we have always been putting pressure on China and asked for help, and, under [former presidents] Obama, Bush and Clinton, we have not seen a significant reaction. Trump’s [hope] is this that by putting more pressure and raising the rhetoric, we might get a more rapid response [from China], but time will tell whether or not that works.”
So what’s the lesson learned here? “First, political crises in emerging markets occur regularly,” says Reynal, who suggests approaching geopolitical events cautiously. “We generally never know ahead of time how quickly a situation can escalate,” he adds. “But more often than not, cooler heads tend to prevail. With this nuclear issue, I suspect things will settle down and pressure will be applied yet again on North Korea, and hopefully with better results.”
Religious and cultural pressures
Reynal points to other long-term global issues that have caused short-term market pain, such as Russia’s involvement with Crimea and the Ukraine in 2014. That, too, was a difficult period for global markets, he says, “but calmer heads prevailed, sanctions were put in place, [and] the reality of Crimea remaining under Russian control was established.”
When it comes to Ukraine these days, he adds, “Russia’s very clear that they will not be controlling the Ukraine in the long term,” but the struggle is ongoing. As reported by CNBC on August 29, German Chancellor Angela Merkel says the sanctions placed on Russia won’t be lifted until Moscow ceases its “imposition on Ukraine.” The U.S., European Union and several other countries imposed sanctions in 2014.
In the meantime, the problems within Ukraine remain unaddressed. As Reynal understands it, “a little-known fact is the problem within the Ukraine is primarily religious and cultural, and it’s not purely about the Russian land grab.”
What does this mean? Says Reynal: “Eastern Ukraine is primarily orthodox and Western Ukraine is primarily Catholic. [What’s more, while] central Ukraine is also orthodox, it’s primarily Ukraine orthodox versus Eastern Ukraine’s Russian orthodox. The point here is there is a cultural identification issue going on, and the Russians are using that, in part, to influence what’s taking place.”
As a result, finding a solution isn’t easy, Reynal notes, and tensions are likely to persist. As an investor in emerging markets, he will keep studying “geopolitical events and where they come from.” Some global events and issues are resolved quickly but, “in most cases, issues will tick along and require monitoring.”