Markets shrug off geopolitical risks as oil remains stable

US, Europe unlikely to confront an assertive Russia; Japanese liquidity to support Asian markets

Strategists tend to believe risks rarely crystalise when one is most aware of these, which is possibly why the equity market on Friday shrugged off the shooting down of a commercial aircraft in Ukraine and the escalation in the Israel-Palestine conflict. At any given point of time, global financial markets are always at the risk from geopolitical disturbances; but this time around, nobody’s losing sleep over it. Typically, geopolitical crisis in West Asia is triggered when the influence of an existing power declines or fades and is replaced by another emerging power, as is the case in Iraq. With the US withdrawing from the region, West Asia has seen a power struggle breakout among warring factions.

Analysts believe this is not the first time that the US’ withdrawal has led to a power struggle. However, the world markets are unlikely to react significantly, as the crude oil market is cartelised and the cartel controls price movement, unlikely to swing substantially in any one direction. Says Saurabh Mukherjea, chief executive officer, institutional equities at Ambit Capital: “What is happening in Ukraine and Iraq does not necessarily translate into risk for global equity markets.” Ukraine is unlikely to be a flashpoint, as the US does not seem to have appetite for any confrontation with a re-assertive Russia.

There has been much talk about a sharp reversal of portfolio investments from emerging markets if geopolitical risks escalate. However, there is plenty of liquidity in world markets. The Bank of Japan announced a massive quantitative easing programme and started buying back government bonds and other risk assets. The biggest beneficiaries of this loosening have been the Asian economies. HSBC Global Markets says: “Japanese capital has helped offset some of the outflows associated with last year’s US Fed 'taper tantrum’. For example, India witnessed $3.8 billion in capital outflows between Q2 2013 and Q3 2013. However, flows from Japan were positive ($0.7 billion) during the period.”

Flows are also coming from Japan in the form of loans and foreign direct investments (FDI), which should support external balances. Thanks to Japan’s loose monetary policy, emerging markets such as India have not felt the impact of Fed’s tapering, expected to end in October 2014. According to Nomura, between April 2000 and March 2014, Japan cumulatively invested $16.3 billion, accounting for around eight per cent of the total FDI inflows into India. In fact, Japan’s FDI investment to India increased almost tenfold in the period 2008-12 from that during 2003-07, making Japan the second-largest foreign direct investor out of advanced economies.”

In the coming months, what will drive Indian equity markets is domestic growth. CLSA’s Chris Wood in his weekly note says: “Greed and fear would advise investors to ignore entirely the alleged disappointment over the Narendra Modi government’s first Budget. Greed and fear will increase India’s Overweight in the Asia-Pacific ex-Japan relative-return portfolio by one percentage point this week with the money taken from Hong Kong.”