Last month the world witnessed a horrible human tragedy break out when the conflict between Hamas and Israel escalated. We’d like to start off by saying our thoughts are with all those affected.
The impact something like this has on markets is rather trivial compared to the destruction of human life. As an investor, it’s understandable to want to know more about how such events could affect your investments.
For November’s Skipton Insight, we take a look at the market reaction to the Israel-Hamas war – including why markets tend to react the way they do to geopolitical risks. And as always, we discuss what it means for you as an investor.
In a nutshell
- So far, the market reaction has been muted to the conflict between Israel and Hamas – with small moves in the price of oil and gold
- Past geopolitical risks show that markets can have short-term reactions but tend to recover quickly
- As an investor you can expect to face geopolitical risks as part of your investment journey. What matters is staying calm and remembering the benefits that come with holding a diversified portfolio over the long-term.
There’s no denying the conflict between Israel and Hamas is devastating. And as individuals, there’s no doubt investors are just as concerned as everybody else. But looking at stock markets as a whole, the conflict so far has had little effect.
The most noticeable moves to occur as of yet has been a slight rise in the price of oil. We haven’t seen a marked increase in investors moving out of shares and into asset classes like bonds in response to the conflict. Bonds are typically seen as a less risky asset for investors to turn to during unpredictable times.
At the moment, it’s hard for markets to judge how this war will pan out. For reasons far greater than the performance of stock markets, hopefully a resolution is reached sooner than later.
But why has the market reaction been so far limited?
Markets are more focused on the economy
The truth of the matter is, markets are more concerned about other factors at the moment – namely inflation and interest rates. As we write this piece (in early November), the conflict sadly rages on. And yet, global shares are on for their best week in a year as markets bet there are no more interest rate rises to come from major economies.
That being said, a continued escalation of the conflict does not come without risk to the global economy. More specifically through the price of oil. The Middle East accounts for just under a third of global oil production. A war in the region could increase the risk of a major interruption to the supply of oil.
As Bank of England governor Andrew Bailey recently told reporters, "It does create uncertainty, it does I think create a risk of higher energy prices. So far, I would say, that hasn't happened and that's obviously encouraging, but the risk remains."
In the immediate aftermath of the initial attacks, the price of Brent crude oil jumped by $4 to above $88 per barrel – although it did fall back shortly after. The increase put an end to the recent decline in the price of oil and there’s room for it to move higher yet. This could feed into higher inflation going forward – much like we saw at the start of the conflict between Russia and Ukraine. And as we well know, energy prices and markets are only just recovering from that.
Geopolitical risks aren’t anything new
First off, what do we mean by geopolitical risks?
These are potential political, economic, military and social risks that can emerge from a nation’s involvement in international affairs. They typically happen when there’s a major shift in power, a conflict or a crisis. These risks could have far-reaching effects for both the country itself and the global community as a whole.
Geopolitical risks will always be a threat to financial markets, global economies and investment portfolios. The past provides us with many examples of geopolitical risks where we saw a knee jerk reaction from markets. But what’s reassuring to see is the long-term impact is usually limited.
- In the week after the September 11 terror attacks, the S&P 500 fell almost 15%. But by the middle of October, the index had recovered nearly all its losses.
- In June 2016 the FTSE 100 fell sharply the morning after Brexit votes were counted. By the end of the year, the index had risen by 20%.
- The same story goes for the S&P 500 after the surprise election of Donald Trump as US President in November 2016. But by the end of 2017, the S&P 500 finished up 35% higher.
- The outbreak of Covid in March 2020 saw global shares drop by a third across six weeks. But by the end of 2021, the value of shares had more than doubled.
- When the conflict between Russia and Ukraine first began in February 2022, shares fell for eight months afterwards. But what’s important to consider is this coincided with US interest rates moving from zero to more than 3% over the same period. And as things stand, both the S&P 500 and UK FTSE 100 are more or less at the same levels they were at just before the beginning of the war.
The potential of a geopolitical risk will always be at play – it’s how the world works. Looking ahead only to next year we have the US election, and as we saw in 2016, nobody knows how that could play out. This also ties in with a steady decline in relations between the US and China, which could lead to limitations in investments and technology cooperation. And let’s not forget that both the Israel-Hamas and Ukraine-Russia conflicts sadly rage on for the time being.
Geopolitical risks are hard for investors to prepare for
John F Kennedy once said, “The one unchangeable certainty is that nothing is unchangeable or certain.”
In the world of geopolitics, this is very true. Uncertainty can be both an investor’s best friend and worst enemy. It can bring attractive opportunities as well as unwanted risk.
Investors tend to accept that, because they know so little about how geopolitical shocks will pan out, the wisest thing they can do is to do little. That’s not to say investors should ignore geopolitical risk, and there is one key thing we can do to help provide a level of protection from these unknowns: diversification.
Holding a portfolio across a range of asset classes and different countries could help to limit the effects of geopolitical shocks which occur in certain parts of the world. And this brings us nicely to our last point.
How should you react to geopolitical shocks as an investor?
We caught up with Kieran Ellis, Skipton’s Technical Research Specialist, to get his views on dealing with geopolitical risks.
As an investor, you can expect to meet geopolitical risks on your investment journey. And whilst short-term market moves may occur, past shocks do show that the average market response is modest and short-lived.
“You should also remember that the most important risks are not necessarily the ones that rolling news channels cover, but it’s more about invisible risks. Such as our own behavioural flaws that can make us our own worst enemies. Those which make us think short-term, rather than sticking to our long-term investment strategies.
“As we’re all too well aware of after the past few years, a diversified portfolio and a long-term view tends to provide a safe path through such times. Market recoveries often begin suddenly, and usually while economies are still struggling. That’s because markets are always looking ahead.”
Past performance is not a guide to future returns. Past economic and market conditions experienced may not be repeated in the future. The opinions and analysis provided are for information only and do not constitute financial advice.
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