Just as the issue of political risk seemed to be coming off the boil, the alleged chemical weapons attack in the Syrian town of Douma has turned up the heat once more. US, French and British forces have conducted air-strikes and more may follow.
This comes after cautious optimism that a number of political risk factors had been contained, including the possibility of a US-China trade war and fears of a nuclear exchange involving North Korea.
Other than those hardy souls who relish the chance to ride the waves of heightened market volatility, traders have an intense dislike of political risk, for the simple reason that it makes what is always an uncertain business considerably more so. Already, they face two types of risks which are now joined by a third.
Neither specific nor systematic risk is welcome to traders but at least both have their causes rooted in the world of finance and economics. Political risk arises as the by-product of actions and events with quite other causes. That makes it all the harder those in the markets to predict how it will play out in terms of asset prices.
A textbook example would be the stock-market crash and recession that followed the embargo on western states imposed by oil producers in the Middle East at the end of 1973 in the wake of the Arab-Israeli war in October. The global political economy took years to recover in terms of employment and living standards.
The ten years after the 1989 fall of the Berlin Wall saw political risk decline to historically low levels. Unsurprisingly, perhaps, stock markets around the world boomed. The bursting of the so-called dot-com bubble in 2000 and the September 2001 attacks on the United States clouded the picture but the risk to market trading still came, in the main, from economic and financial causes.
That changed four years ago, with China stepping up its claims not only to Taiwan but to other islands and sea lanes and the Russian annexation of Crimea. Perhaps more alarmingly, North Korea not only successfully detonated a nuclear weapon but boasted that it could deliver the warheads not only to its southern neighbour but to the US state of Hawaii.
Finally, in the wake of the financial crisis, the political environment of business changed markedly. The prospect, frequently realised, of ever-tighter regulations on the financial sector not only represented political risk for the institutions concerned but generated market risks as tough new rules forced banks to withdraw from their traditional role of market making in securities, removing an important shock absorber.
At the start of this year, any analysis with a heading such as “stock market predictions 2018” would have flagged up all these sources of risk. But more recently, the skies seemed to be clearing. President Trump’s tough talking appeared to have brought a more emollient approach from North Korea, while China seemed willing to make concessions to avoid a trade war.
Mr Trump also moved to relax some of the post-crisis regulations and his tax cuts, passed by legislators at the end of last year, appeared to be good news not only for US taxpayers but for the world economy in general.
Markets responded positively. America’s blue-chip Dow Jones Index, which had languished below 20,000 points between 2014 and 2017 and barely broke above 24,000 last year, topped 25,335 in early March. It was a similar story for Tokyo’s Nikkei 225 Index and the FTSE 100 Index in London.
All are now off their highs of earlier this year.
So how should a trader cope with political risk?
There are, of course, no guarantees that someone’s market position can be shielded entirely from financial turbulence, but adherence to some basic principles should improve their chances.
The first is the critical need to read and assess all the sources of political risk. Do not be distracted by one or the other and assume they are the sole source of danger. Crises do not form orderly queues, and the Syrian debacle does not mean tensions in the Far East have gone away.
Next, the trader ought to seek out any connections between these various types of risks. Syria is an oilexporter and neighbours some very substantial oil-producing states, so crude prices could be expected to rise in response to supply disruption. China and Turkey are among its biggest export markets, while Russia, Turkey and China are the source of more than 50 per cent of its imports.
All these factors need to be taken into account. Similarly, conflict on the Korean peninsula would have an impact not only on South Korea, which is a developed country and a member of the Group of 20 leading economies, but on nearby Japan, which is the fourth-largest economy in the world.
Finally, all this information can then be used to draw up a strategy of diversification. Even during periods of relative calm, diversification makes good sense for any trader. But it is essential during times of heightened political risk.
There is, of course, more to diversification than simply trading apparently-disparate asset classes. It involves looking for hidden connections between one asset and another.
For example, the risk arising in the Shanghai stock market three years ago when the authorities took draconian measures to stop share prices from falling may seem to have little to do with a decision to trade the Australian dollar. But the dollar’s value remains closely linked to commodity exports, for which China is a hugely important customer.
Had the Shanghai market crisis spilled over into the real economy, trading the Australian dollar would have offered little diversification from Chinese shares.
Political risk may be deeply un-welcome to traders but it has to be lived with. It is possible that the two decades after 1989 were untypical and that recurrent political risk is the norm in financial markets. If so, successful trading requires a robust and well-informed strategy for coping with it.