What value should sharemarkets put on geopolitics?

How do equity market analysts put a value on geopolitical shocks?

“We don’t,” says MST Marquee’s strategist Hasan Tevfik.

For the past few years, big investors such as the Future Fund have been calling out the rising influence of geopolitics on sharemarkets, and have recalibrated their trading strategies around this.

While this adds a broad risk overlay, the problem is individual events are becoming impossible to predict. And their impact are just as hard to quantify.

“Be very careful of responding to events,” Tevfik tells The Australian.

Donald Trump’s surprise bombing of Iran last weekend* was a case in point. The significance of the dramatic intervention in the Middle East and likely impact on oil markets had investors fearing the worst in the hours following.

Yet Wall Street is on track to finish this week higher*, while Australian shares have also ended in positive territory over the week*. Oil is now lower than before Israel began it surprise air strikes.

[* Note, this article was first published in The Australian on June 27.]

Tevfik is regarded as one of the nation’s leading market strategists, with stints at Citi and Credit Suisse. He points out the downside – or even the upside to geopolitical shocks – have almost always been less material than initially thought.

“The outcome of a geopolitical event is almost always negative (for the market), but there’s been key events that have occurred in the already slowing environment that could have accelerated the downside or turned a slowdown into a recession,” he says.

The Ukraine war could have been one of these events, he says. The then surge in oil and energy became the trigger to accentuate the downside that had already started to set in at the start of 2022.

The most notable shock event was September 11, 2001, when the US economy was already well into a slowdown, however it was the attack on New York that pushed it into recession.

Strategists are sought after for their macro views of the market. Their work is part science with a large dash of opinion. It involves inputting myriad variables including interest rates, yields, growth and earnings multiples into a financial model to spit out a valuation. It can be sector-specific, or more often goes wide and looks at the entire market.

Notably, Tevfik has turned bearish on the outlook for the market. He is forecasting Australia’s benchmark S&P/ASX 200 to be back at 8000 points by the end of the calendar year. The Australian market is currently hovering near record highs, implying a 6 per cent fall from current levels.

“We’re expecting a US recession. Whenever you’ve seen a US recession, there’s been an Aussie profits recession. So the association between Aussie profits and the US economy is actually much tighter.

“Anything that is financial markets facing, so things like Macquarie Group or the fund managers or platforms exposed to a US recession, they’re going to suffer. Our entire building materials sector is exposed to the US, as we saw with Reece – expect more downside there.”

Plumbing supplies play Reece issued a profit downgrade on Friday, saying it had been hit by a slowdown in residential construction. This triggered a near 20 per cent single-day share price plunge.

Global shares have since more than recovered the losses from Donald Trump’s April 2 “Liberation Day” tariff announcement. Is this another example of a shock that’s come and gone?

“To be fair, you haven’t seen the consequences of the rise in tariffs on inflation yet,” Tevfik says.

It’s also too early to start factoring a change in market dynamics or benefit to the economy from AI. Instead, Tevfik is treating the tech much like the initial days of the internet where there was money pouring in but, business models were yet to be proven.

“It (AI) is the one of the primary drivers of bubbles or exuberant valuations right now. I’m sure it would drive earnings down the road. At the same time, it’s going to be a serious headwind for anyone that is an online aggregator.”

End of the deal

New Woolworths boss Amanda Bardwell has started to unwind a costly spending spree by former chief Brad Banducci, as she pushes ahead with her review of a bloated portfolio.

It’s a small but significant step where Bardwell will shut down the loss-making MyDeal online marketplace. The scrutiny is long overdue, and expect more closures or exits of Woolies brands to come.

The MyDeal move comes after Banducci picked up the business just three years ago for $243m, but struggled to offer a compelling rationale for the deal. The timing was bewildering given the substantial problems Wesfarmers was having with its own standalone digital marketplace Catch.com.

Closure is an expensive exercise for Woolies. It will come at cost of up to $145m, including buying out the remaining 20 per cent stake Woolies doesn’t own from MyDeal’s founders and some non-cash writedowns. After adding in combined losses over two years of ownership, the adventure may end up costing shareholders in excess of $420m.

Like Wesfarmers found with the now closed Catch, MyDeal was competing in a digital marketplace dominated by the likes of Amazon, eBay and, increasingly, Chinese heavyweight Temu. As a standalone brand, it simply couldn’t generate a compelling offer for customers in terms of range and competitive advantage. It’s right for Bardwell to ask: “What are we doing in this space?”

Wesfarmers paid almost the same amount for Catch ($230m) in 2019 but sunk hundreds of millions more into the business through investments and combined losses. Unlike Woolworths, Wesfarmers broke out the Catch business.

Wesfarmers argues strongly the closure wasn’t all a lost cause, the hi-tech Catch warehouse and technology is now being used to power the Kmart third-party market place.

Bardwell is hoping to get the same result, by using the IP from MyDeal to power the Big W digital marketplace and Woolworths-branded Everyday Market for its groceries business. Combined, these businesses, including MyDeal, operate under Woolworths’ MarketPlus banner.

Woolies didn’t break out the earnings, but analysts including Citi estimate MyDeal was generating losses of around $20m annually with no path to profitability.

The move by both Woolies and Wesfarmers shows how quickly the business model can change in the digital space, with today’s glamour trend rapidly losing currency. It also a cautionary note for management around the risks of distraction by moving into adjacencies – even for relatively small businesses.

Banducci launched a string of acquisitions in the final years of his tenure, including $586m for a 55 per cent stake in pet care chair Petstock. (The price tag was later trimmed after the ACCC forced the sale of nearly a dozen stores.) Woolies also acquired wholesale food delivery business PFD in a two-step deal for almost $700m. PFD has since been folded into a new business to business unit, while earnings from Petstock or MyDeal aren’t broken out. These deals were struck as sales momentum and performance at the flagship supermarkets business was deteriorating.

MyDeal is a quick win, but is not going to move the dial for the $40bn Woolworths. Still, the closure sends a message that Bardwell is putting performance rule across the portfolio. The real test will be when she starts looking at how two long-term problem businesses fit in the portfolio – Big W and New Zealand supermarkets.

This article first appeared in The Australian as Sharemarkets find it impossible to put a value on geopolitics

Eric Johnston is an associate editor of The Australian. He has more than 25 years experience as a finance journalist, including a former business editor of The Australian. He has been business editor of The Sydney Morning Herald and The Age and financial services editor with The Australian Financial Review. His work has also appeared in The Wall Street Journal.