Geopolitical Risks

Henry wrote:

I’ve read that the market is at the mercy of geopolitical risks. Do you think so? Also, what do you consider to be the biggest geopolitical risks facing us today?

The market is no more at the mercy of geopolitical risks today than it has been in the past. People suffer from a number of cognitive biases that impair their investment performance. One of them is hindsight bias, which is the tendency to think past events were predictable when they were not. Another, which has no name that I’m aware of, is a tendency to assign a higher perception of risk to future possibilities even when we know how similar events have played out in the past. It’s forever worse this time.

For instance, you often hear phrases like “in today’s environment” or the “current challenges facing us” or “in light of the current crisis” as if the world is far worse today than it’s ever been.

It’s not. Some history books will come in handy.

If you think American involvement in the Middle East is new, peculiar to President Bush, and destined to end the moment he leaves the White House, you need to read Power, Faith, and Fantasy by Michael Oren.

If you think nobody’s ever thought about the end of oil before and that its increasing demand and decreasing supply is a new issue, you need to read Twilight in the Desert by Matthew Simmons. You might also brush up on Peak Oil Theory and Hubbert’s Peak, and maybe spend some time reading The Oil Drum.

The world has been aware of oil’s approximate time line for more than three decades now. While most people think governments and oil companies are just stupid, what’s actually happening is a fine balancing act between being able to sell as much oil for as much profit as possible before the environmental cost gets too high and/or the social pressures too great.

The annoying secret is that we could survive without oil right now. The technology exists. Ask anybody who’s driven a forklift inside a warehouse how often they need to fill up. Never. Those vehicles have been electric for 50 years. We don’t wean ourselves from oil because big companies want to sell it, governments want to tax it, and people keep buying it.

If you think recent natural disasters like Cyclone Nargis in Myanmar and the earthquake in China are worse than the world has seen before, you need to read a list of natural disasters. Keep in mind that the global population grows every year, so we should expect death tolls to rise over time simply because there are more of us to die. An earthquake of the same size will kill more people in a crowded area than a non-crowded one.

Even so, Cyclone Nargis and the China earthquake are not even close to being the deadliest natural disasters on record. China is no stranger to nature’s wrath. Its floods in 1887 and 1931 killed more than one million people, its Jiajing earthquake in 1556 killed more than 800 thousand people, and its Great Tangshan earthquake in 1976 killed more than 200 thousand people.

Besides, natural disasters have no bearing on financial markets. It’s the mark of an amateur to think that Hurricane Katrina will stop the U.S. economy in its tracks, or that China’s earthquake will shake its economic foundations. I’m not being callous toward the toll disasters take on humanity, I’m referring only to their non-impact on financial markets.

The U.S. stock market has averaged a little more than 10% per year through World War I, The Great Depression, World War II, the Korean War, the Vietnam War, the Gulf War, the Iraq War, and smaller military excursions scattered between. It’s also ignored Jazz, Rock & Roll, Disco, and Hip Hop. It hasn’t cared much about changing fashions, either, nor who’s in the White House.

The geopolitical risks we face today are no worse than what we’ve seen in the past.

That being fully grasped, I would say that the one with the highest chance of affecting the market for a short time would be a U.S. attack on Iran because oil prices are already high and that would likely take them higher.

What are the odds of such an attack? Pretty good, apparently:

  • Israel’s Army Radio reported that President Bush plans to strike Iran before the end of his term.

  • The U.S. Air Force refitted its stealth bombers to carry 30,000-pound “bunker buster” bombs, which would be necessary to destroy Iran’s reinforced nuclear facilities.

  • The Saudi Arabian government began making nuclear fallout preparations against possible contamination from the U.S. destruction of Iran’s nuclear facilities a day after Vice President Cheney met with their highest-ranking officials. What do you suppose they discussed?

  • Israel’s getting ready, too. Last month, it ran its largest homeland military exercises ever.

  • The U.S. now has two aircraft carriers deployed in the Persian Gulf. The USS Abraham Lincoln joined the USS Harry Truman this month, and with more weapons and ammo than on previous deployments.

The Bush administration said that the military option has not been taken off the table, but that it would like to settle worries over Iran’s desire for a nuclear weapon “through peaceful diplomatic means.”

Should this affect how you manage your portfolio? No. Aside from keeping a wish list of stocks to buy should an amazing sale happen unexpectedly — which you should always maintain — there’s no point in acting on unsubstantiated claims about an event that would bring only fleeting market consequences anyway.

You can read more on the Iran situation in this morning’s Journal.

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