Is the world becoming a safer place to live (and invest) in? The obvious answer is yes - there hasn't been a world war for nearly 70 years. And yet the headlines seem to be full of worrying developments in Iraq, Syria, Gaza and Ukraine. But you could argue that letting off steam in such regional conflicts is one way of preventing the more unpredictable consequences of a bigger explosion - witness the chain reaction that kicked off World War 1.
However, there are more subtle risks to stability than a world war. Emiel van den Heiligenberg, head of asset allocation at Legal & General Investment Management, identifies four main risks. The first is growing inequality. The average income of the richest 10 per cent of OECD citizens is now nine times the income of the poorest 10 per cent - up from seven times a quarter of a century ago. This adds to the political risk, as extremist parties gain traction.
The second risk comes from the polarisation of US politics, which has undermined the traditional role of the US as a global police force. Then there is the rise of China: its emergence as an economic and military power is already ratcheting up geopolitical tension in the Far East, and that could spread. Finally, technology itself poses a risk, as more widely used communication systems provide an ideal incubator for cyber crime and terrorism.
For investors seeking to mitigate risk, these present a problem. Economic trends, if not always welcome, are at least very broadly predictable. Geopolitical incidents are not, and this makes it impossible to get ahead of the curve. Initial market reactions to events may include a higher equity risk premium, greater volatility and a dash for government bonds - even if the event is inflationary, such as a spike in oil prices.
Given that such events are impossible to predict, at least in the timing, there is an opportunity to profit not so much from the market's reaction but from its overreaction. With the occasional exception, market-moving shocks rarely last, so taking a bet on a return to more normal trading can generate a useful return.
However, different markets react in different ways. There is a positive correlation between liquidity, experience and better functioning systems on the one hand, and the amount of market reaction on the other. So the US and UK markets, for example, may ride out storms better than some smaller or emerging markets.
It might also be the case that investors have become somewhat immunised to shock events such as 9/11, because history has shown that after an initial panic reaction the financial world continues to turn. And it's useful to differentiate between risk and uncertainty. For example, rising interest rates pose a risk to asset prices, but there is no uncertainty: we all know it's going to happen.
Next week's economics...
The usual feast of economic data next week has been reduced to a few meagre crumbs in the UK, but the US will continue to churn out a variety of economic indicators. On Tuesday, the consumer confidence index for August is due for release, with consensus forecasts suggesting a fall from 90.9 in July to 89.5.
This is an important indicator because the bulk of US GDP comes from consumer spending. Moreover, without perceptions of an improved economic climate, the housing sector is going to struggle to maintain any momentum. House prices have recovered from the depths hit two years ago, but a lot of people still seem to be putting off buying a house. Demand for new homes has fallen sharply over the past six months, probably due to restrictive lending rules and rising mortgage rates. The implications are far-reaching: the construction of new homes is a key driver of the US economy, historically accounting for around 5 per cent of GDP (although in recent years it has fallen to 3 per cent).
News on this front will come with Thursday's release of second-quarter GDP estimates. Quarter-on-quarter growth (annualised) is expected to fall from 4 to 3.8 per cent. As in Britain, the US authorities will be keeping a watchful eye on weak wage growth, with personal income data on Friday expected to show wage growth slipping to just 0.3 per cent in July, from 0.4 per cent in June. More worryingly for consumer-facing companies, personal spending growth in July is expected to have halved from June to just 0.2 per cent.
