Geopolitical risk has been creeping back into the markets.
as well as regarding on-going uncertainties the US-Russia relationship.
And geopolitical risk indices are now at elevated levels relative to the last 100 years, according to chart shared by a Bernstein Energy & Power team led by Oswlad Clint, citing data from the Federal Reserve Board.
They aren’t at the levels of WWI and WWII, or even 9/11 and the 2003 invasion of Iraq. But they are at higher levels than those seen during the Vietnam War and ahead of the Six-Day War.
Geopolitical instability and oil markets have historically been linked. Tensions and conflicts sometimes lead to oil production going offline, which then leads to higher oil prices. The last couple of years, however, have not seen a significant uptick in oil prices, despite increased geopolitical risk amid the oil supply glut.
“While few of these events have acted to boost oil prices in the last 12 months or so that’s a function of elevated inventories,” Clint wrote. “Once they drain then stronger oil price volatility may return.”
“In that view, it’s useful to recognise that when we consider current geopolitical risk relative to that last 100 years, it’s high,” he added. “Some type of geopolitical outage therefore seems more likely than not to happen. That would be positive for oil prices.”
Although geopolitical risk has been linked with oil prices, history has shown time and time again that geopolitical shocks themselves rarely have a sustained effects on markets.
Reviewing data on major geopolitical events in the past 100-plus years, Credit Suisse’s former head of research and deputy global CIO Giles Keating and his team previously found that stocks generally bounced back after such shocks.
“The large majority of individual major events — ranging from the assassination of Archduke Ferdinand 100 years ago through to 9/11 and recent events in Iraq and Ukraine — impact major stock markets by around 10% or less, with the effect being fully reversed within a month or so,” he wrote in a note to clients. “This suggests that the most profitable strategy has usually been the contrarian one of buying into price falls caused by such incidents.”
As an example of what this looks like, a Credit Suisse research team led by Andrew Garthwaite last year shared a chart showing what the Hang Seng looked like in the immediate and long term after the Tiananmen Square protests.
“In our experience, markets tend to over-react to political shocks, as was seen in the example of Tiananmen Square — where the Hang Seng fell 22% in a single day, losing 37% from its peak over the entirety of the protest period, before steadily recovering back to previous peak over the following year,” the team wrote.
True, there have been several times that markets didn’t recover as quickly, after seismic geopolitical events such as the invasion of France in 1940 and the Yom Kippur War (which led to a complete realignment of control over global oil).
But even then stocks saw recoveries within 2-3 years, according to Credit Suisse.
Notably, Warren Buffett also champions the stay-calm-when-all-hell-breaks-loose strategy. At the height of the financial crisis, in October 2008, he wrote in a New York Times op-ed article:
“Over the long term, the stock market news will be good. In the 20th century, the United States endured two world wars and other traumatic and expensive military conflicts; the Depression; a dozen or so recessions and financial panics; oil shocks; a flu epidemic; and the resignation of a disgraced president. Yet the Dow rose from 66 to 11,497.”
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