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Living in a connected investment world

Nothing happens in isolation when it comes to global financial and investment markets. Indeed, chaos theory where a butterfly’s wing flap in the Amazon can eventually lead to a typhoon in Asia is often cited to highlight the complex connections involved.

The law of unintended consequences

Seemingly minor events in one part of the world can have a profound impact in another while apparently positive developments can produce unexpected negative impacts. A regional election result in Venezuala, for example, can cause an oil price fall spelling great news for energy users but not so good for oil companies, their shareholders or oil exporting economies.

The law of unintended consequences should always be borne in mind. US promotion of biofuels and other alternative energy sources in the early part of this century served to drive oil prices down. But a large proportion of the biofuel supply was manufactured from cereal crops. This caused a shortage of cereals leading to increased food prices across the globe. Farmers too had to contend with higher animal feed prices. This has had adverse consequences for companies across multiple sectors but very positive impacts for industries heavily dependent on oil as an input, such as the airline industry.

Similarly, storms in the American mid-west can cause grain price rises with a knock-on effect on bread, animal feed, and a whole range of other commodity prices with resulting impacts on the share prices of a whole range of companies – some positive, some negative.

There’s no such thing as a safe bet

In each case there are winners and losers. Of course, investors want to be on the winning side as often as possible but tracking the vast number of variables involved is next to impossible for an individual investor. This is just one reason why it is always best to have a diversified investment portfolio, for the difficulty is not in being able to monitor the various events which may have an impact on global markets - the real problem lies in assessing their likely impact. Recent events in the geopolitical sphere offer interesting examples.

In the case of both the Brexit vote in the UK and the election of President Trump in the US the expectation among many was for an adverse market reaction. The opposite was the case in the US while the UK financial and investment markets have remained remarkably steady.

On the other hand, anyone expecting a dramatic rise in the value of the euro following the election of President Macron in France will have been disappointed. The euro actually fell in the immediate aftermath of the result becoming known – mainly because the markets had anticipated the outcome and the currency had increased in value the previous week. The fall came about as a result of investors taking profits on their earlier investments.

Diversify to exemplify

The very good news is that the same connectedness means that no event ever happens in isolation. Other factors and events are always at play. Lower prices for a commodity like milk will eventually lead to increased consumption which will drive prices higher again. Companies which experience increased costs in one country may invest in another lower cost location. Increased oil prices usually lead to higher share prices in the energy sector while lower prices deliver increased profits and share prices for the airline and other sectors.

Even if an individual could keep track of all of these events the chances of them predicting the eventual outcome every time are incredibly low. The wisest strategy is to diversify your investments, take professional advice and accept the expertise of an investment manager. A diversified investment portfolio will help mitigate risk and increase your chances of benefiting from positive outcomes, investment managers can add expertise and risk management strategies to help protect against unexpected changes such as currency movements, while professional advice will help you make the right investment choices for you.