History suggests market shocks from geo-political events typically don’t last, according to AMP chief economist Shane Oliver.
Escalating tensions between the US and North Korea last week caused volatility in global markets, although the threat of conflict appears to have eased for now.
“The risk of war has grown but a diplomatic solution remains most likely although there could still be more volatility before this is finally achieved,” Oliver said in a note to clients
He added a chart to his analysis which shows that North Korea has become increasingly fond of launching missiles under its current leader Kim Jong-un:
In looking at the potential implications for investors, Oliver cited historical examples which show how US stocks have reacted to major conflicts that America has been involved in since the second world war.
Oliver focused on US stocks as the S&P500 has historically set the direction of other western markets.
Noting that there have been many smaller conflicts in that time, Oliver narrowed his criteria to major military events which have had a material effect on markets. Here’s the table:
Looking at recent history, US involvement in Iraq in both 1990 (Iraq War I) and 2003 (Iraq War II) led to a fall in stocks of more than 10%.
In both cases, market volatility bottomed out well before the end of the conflict. Oliver adopted a time frame of August 1990 — January 1991 for Iraq War I, and March — May 2003 for Iraq War II.
The key takeaways from the historical analysis are that shares initially fall as markets assess risk, but history suggests that within six months, they always rise strongly.
Oliver also noted that how stocks were performing prior to the conflict can also influence how much they fall.
“For example, prior to World War 2, the Cuban Missile Crisis and the two wars with Iraq, shares had already had bear markets. This may have limited the size of the falls around the crisis,” Oliver said.
It’s fair to say that’s not the case now, as market volatility last week saw US stocks dip from their recent all-time highs.
“The intensification of the risks around North Korea comes at a time when there is already a risk of a global share market correction,” Oliver said.
He noted that the S&P500’s climb to new record highs this year has been driven by just a small number of big companies and sentiment indicators also reveal a high degree of investor complacency.
Oliver added that the market’s expectations for the next rate rise by the US Federal look to be too low.
“However, absent a significant and lengthy military conflict with North Korea (which is unlikely), we would see any pullback in the next month or so as just a correction rather than the start of a bear market,” Oliver said.
“While there is a case for short-term caution, the best approach for most investors is to look through the noise and look for opportunities that North Korean risks throw up – particularly if there is a correction.”
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