Deborah D’Souza* says investor attitudes to war and uncertainty in the modern era can be counterintuitive.
Coming up on the 75th anniversary of the end of World War II, the world is now focused on the possibility of an armed conflict between the US, its allies and Iran.
So far, the US has spent an estimated $6.4 trillion on wars post 9/11, and going by the President’s latest tweets, it appears willing to keep spending if things escalate.
But there is little clarity of how far Iran, its economy already struggling and its leadership deeply unpopular, is willing to go to avenge the death of its top general.
Security experts are weighing in, and only time will tell, but investing experts are sending out reminders that past wars didn’t push US equities lower in the long term.
LPL Financial said in a note that stocks have largely shrugged off past geopolitical conflicts.
“As serious as this escalation is, previous experiences have indicated it may be unlikely to have a material impact on US economic fundamentals or corporate profits,” said LPL Financial Chief Investment Strategist, John Lynch.
“We would not be sellers of stocks into weakness related to this event, given stocks have weathered heightened geopolitical tensions in the past.”
“From the start of World War II in 1939 until it ended in late 1945, the Dow was up a total of 50 per cent, more than 7 per cent per year,” wrote Ben Carlson, Director of Institutional Asset Management at Ritholtz Wealth Management, in an article about counterintuitive market outcomes.
“So, during two of the worst wars in modern history, the US stock market was up a combined 115 per cent.”
“The relationship between geopolitical crises and market outcomes isn’t as simple as it seems.”
History tells us periods of uncertainty like we’re seeing now are usually when stocks suffer the most.
In 2011, researchers at the Swiss Finance Institute looked at US military conflicts after World War II and found that in cases when there is a pre-war phase, an increase in the war likelihood tends to decrease stock prices, but the ultimate outbreak of a war increases them.
However, in cases when a war starts as a surprise, the outbreak of a war decreases stock prices.
They called this phenomenon “the war puzzle” and said there is no clear explanation why stocks increase significantly once war breaks out after a prelude.
Similarly, Mark Armbruster, the President of Armbruster Capital Management, studied the period from 1926 through July 2013 and found that stock market volatility was actually lower during periods of war.
“Intuitively, one would expect the uncertainty of the geopolitical environment to spill over into the stock market,” he said.
“However, that has not been the case, except during the Gulf War when volatility was roughly in line with the historical average.”
In terms of the Iran conflict, however, investors have had a muted reaction to the headlines.
“If 2019 taught us anything, it’s that you have to try as best as possible to keep to your process and not get caught up in the headlines,” said Strategas technical analyst Todd Sohn to The Washington Post.
“In a sad way, I wonder if we’ve become used to it.”
“I wonder if the market has learned to discount these events.”
“Part of the reason for the calm may lie in the changing structure of global oil markets and how the US economy has become less vulnerable to energy price swings,” said JPMorgan Funds Chief Global Strategist, David Kelly in a note.
“Part of the reason may be purely psychological.”
“Today’s investors have seen the stock market recover from both 9/11 and the Global Financial Crisis, arguably the greatest geopolitical and economic shocks of our time.”
“This makes it easier for investors to shrug off other events.”
“Over the last few years, markets have been conditioned not to overreact to political and geopolitical shocks for two reasons: first, the belief that there would be no significant subsequent intensification of the initial shock; and second, that central banks stood ready and able to repress financial volatility,” said Mohamed Aly El-Erian, the Chief Economic Adviser at Allianz, in a Bloomberg column.
But he warned that investors buying the dip should use a selective overall strategy.
“This includes emphasising up-in-quality trades that are anchored by robust balance sheets and high cash-flow generation, resisting the strong temptation for large-scale shifts away from US assets in favour of international investments, and reducing exposure to inherently less-liquid market segments that have experienced beneficial spill-overs from extraordinary central bank stimulus and the general reach for yield and returns,” he said.
* Deborah D’Souza is News Editor at Investopedia. She tweets at @d_dsouza26. Her website is deborahdsouza.contently.com.
This article first appeared at www.investopedia.com
