Seemed like a good time to write about this, since this topic looks like it will be of interest for a while. What happens when war breaks out? Death, disaster and destruction. But outside of the obvious and the tragic…
One likely immediate question that emerges is what it means for investors, and what action (if any) is called for. This short note is our attempt to answer this question.https://www.capitalmind.in/2023/10/geopolitical-conflict-markets/
It’s a nice and short post, the on we’re talking about today, and can be read fairly quickly. The first chart itself is quite instructive:
It’s instructive for a lot of reasons, but not all of them are obvious:
- War seems to have an immediate (and negative) impact on equity markets.
- But we actually cannot say so for sure, and for two reasons. One, the relatively small sample size. And two, there are likely hajjar other things that are also going on in the world, and the dip may well be because of these other factors. In fact, the war itself may have been caused by some (or all) of these other factors. Econometricians will chomp at the bit upon reading this, but it suffices for us to know that establishing causality can be tricky.
- The severity of each event, in terms of their impact on American equity markets is difficult to measure. It would seem safe to say that 9/11 had a bigger impact on equity markets than did the US operation in Cambodia, for example. But the Iranian hostage crisis – did it have the same impact as the US invasion of Panama? For the same reasons or other reasons? What has changed in the intervening ten years in the global economy, in the USA, and in specific markets within the USA?
The rest of the post is definitely worth a read, and the research seems to indicate the following:
- It takes somewhere between one to three months for markets to mean-revert after a particular event. This event could be positive or negative.
- For negative events, markets end up being about 2% below pre-event level a month or so after adverse events.
- Risk aversion seems to go up on part of investors
- Markets seem to react more to negative news than positive news (who woulda thunk it?!)
- Emerging markets have higher sensitivity to such events than developed markets.
- Markets are quick to price in perceived threats, and the actual event itself therefore does not see that much of a reaction.
As regards that last point, see this from Taleb:
If you asked any intelligent “analyst” or journalist at the time, he would have predicted a rise in the price of oil in the event of war. But that causal link was precisely what Tony could not take for granted. So he bet against it: they are all prepared for a rise in oil from war, so the price must have adjusted to it. War could cause a rise in oil prices, but not scheduled war—since prices adjust to expectations. It has to be “in the price,” as he said. Indeed, on the news of war, oil collapsed from around $39 a barrel to almost half that value, and Tony turned his investment of three hundred thousand into eighteen million dollars.Taleb, Nassim. Antifragile: Things that Gain from Disorder (p. 210). Penguin Books Ltd. Kindle Edition.
Tricky thing, predicting markets!
If you would like to read a more detailed review of the literature on this topic, I would suggest the section titled “How Sensitive Are Markets to Armed Conflict” from this paper (pp 625)