In One Chart: Geopolitical risk is at a nearly three-year high — here’s why that’s not a reason to sell stocks

Despite some concerns about valuation, the global economy looks strong enough that one of the biggest risks facing stocks in 2018 may not actually be something to fear.

Geopolitical issues are widely considered one of the biggest potential headwinds facing markets in the new year. In addition to ongoing tensions between the U.S. and North Korea, the investigation currently being conducted by special counsel Robert Mueller has been cited as a factor that could lead to volatility. Political issues are seen as harder to predict than the economic factors that drive market action, and, because of this, the sudden emergence of such an issue can have a pronounced impact on trading, at least in the short term.

BlackRock’s Geopolitical Risk Indicator is currently at its highest level since March 2015, “and well above early 2017 levels, when markets were digesting Donald Trump’s election win, worrying about the French election outcome and fearing the potential for a hard Brexit,” wrote Richard Turnill, BlackRock’s global chief investment strategist.

Chart courtesy BlackRock

Turnill noted that the indicator, while at a multiyear high, was still below other recent peaks, including spikes related to the events that came to constitute the Arab Spring, concerns about the integrity of the eurozone, and the conflict between Russia and Ukraine over Crimea.

Despite that, he suggested the issue was still a cause for concern. “We are starting 2018 with geopolitics clearly on the radar screen,” he wrote, adding that “we believe risks such as a more muscular U.S. approach on trade bear watching.”

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BlackRock’s indicator tracks the frequency of geopolitical risk mentions in both media and brokerage reports, and then adjusts that data for sentiment. Based on one measure, bullish investor optimism is currently at a seven-year high, leading retail investors to up their exposure to equities to record levels. Repeated records in major indexes like the S&P 500 SPX, +0.17% have also kept traders in stocks.

Geopolitical risk has largely been taking a back seat of late, with stocks shrugging off all manner of potential headwinds as investors instead focused on improving corporate profits, a strong labor market, and the recently passed tax-reform legislation in Washington, which is seen as supporting stock prices by cutting corporate tax rates, among other changes.

For this reason, Turnill wrote that while political issues were in focus, “the economic backdrop is solid … [and] we do not expect geopolitics to disrupt this trend.”

He added, “Our base case: Geopolitics do not disrupt markets’ risk-on tone in 2018 other than briefly.”

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