With hostilities raging in the Middle East and Eastern Europe, the resultant humanitarian tragedies weigh heavily on caring individuals, even for those of us fortunate enough not to have loved ones directly affected by the strife.
As investors, our minds may also turn to the potential financial market impact of the conflicts.
I participated in a conference call recently on geopolitics hosted by Goldman Sachs. The guest speaker was Retired General Sir Nick Carter, whose last assignment was chief of the Defense Staff for the United Kingdom (the US analog is the Chair of the Joint Chiefs of Staff).
The first message for investors: geopolitical tensions are rising, and with higher tension comes higher risk.
General Clark examined the situations in Gaza / Israel / Iran; Ukraine / Russia; China / Taiwan; and North Korea – through the lens of current or potential future military engagement.
The flashpoint that concerned Clark most was Iran’s recent drone and missile attack on Israel, following the Israeli attack on the Iranian consulate in Damascus on April 1.
Clark stated that this was the first time since the founding of the Islamic Republic of Iran in 1979 that Iran has mounted a direct attack on Israel. In Clark’s words, “we’ve reached another level in terms of escalation.”
Additionally, Clark sees the Israeli / Hamas situation as near unsolvable; the Russia / Ukraine war as intractable; China’s objective of gaining control of Taiwan unmovable; and North Korea’s desire for nuclear weapons insatiable.
Clark concluded by wondering if the system of rules-based international order, put in place after World War II, will survive; and if not, what might replace it.
This was clearly a heavy report with a discouraging prognosis.
The second message for investors: bad geopolitical outcomes infrequently bring about extended stock market declines.
While far from uplifting, past experiences may serve to allay the worst fears related to the potential market impact of escalating geopolitical risk.
The table below from Goldman Sachs presents twelve hostile geopolitical events and stock market performance over three subsequent periods: the next day, 30 days later, and low point in the market following the event (which may have occurred before or after the 30-day mark).
The key take-away from this chart: adjusting portfolio positions in anticipation of a bad geopolitical outcome is a hit-or-miss strategy. In six of the twelve instances, stocks were in positive territory one month after the event.
Stock market drops concurrent with negative geopolitical events are often significant, as the low point in the chart above depicts, but the duration of the impact is impossible to know, and other influences and countervailing events can affect stock prices, too.
Also, the negative stock market impact of geopolitical events tends to be in line with normal stock market declines experienced in years that did not include a hostile geopolitical event.
Since 1980, the average intra-year stock market drop has been 14.2% (see the first chart in the previous section of this letter).
It is understandable if you are troubled by geopolitical risk and worry about how it might affect your investments. Recent events have been distressing, violent, and cause a strong emotional response for many of us.
However, from an investment perspective, remaining dispassionate is recommended. Sticking to your investment approach and your financial plan will serve you well in the long term.
-RK