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How do geopolitical events impact returns?

Returns at times of conflict: a table with a series of recent wars and the S&P 500 returns (Table by Bloomberg LP)

The new decade has started with geopolitical tensions. The US military strike on Quasam Soleimani heightened market anxiety and led to a brief dip in the markets. No one knows where this confrontation will ultimately lead, just like no one knew about 9/11, or the Iraq invasion, or the attack on Pearl Harbor. While many pundits take headline queues and pontificate on near-term market outcomes, the truth is they are merely speculating on something that historically has meant little to stock market returns. Not to downplay war and strife from a social and humanitarian perspective, but its effect on markets is far less devastating. Geopolitical events that directly affect the functioning of the economy, like, for example, a change in political leadership that adopts a more socialist agenda, can negatively impact markets to a much higher degree. If events directly affect business and the profitability of companies, there are far more significant ramifications. The global economy can function with limited effect in the face of isolated battles and isolated wars. Of course, conflicts will directly affect the companies that operate in the war-torn country, but global companies have dispersed operations and supply chains that are more flexible than most would like to admit. Generally speaking, running for the hills on negative geopolitical headlines can be costly. There will always be tensions that sound terrifying, but, in retrospect, are minor in terms of financial market impact. From a recent Institutional Investor article (bold emphasis mine):“According to Dimensional, if an investor put $1,000 into the S&P 500 index in 1970 and left it there, it would have grown to $138,908 by the end of August 2019. If investors missed the 25 best performing days because they sold stocks as a result of their nerves or a strategist’s market forecast, that portfolio would be worth only $32,763.” See the table accompanying this article, featuring a series of recent wars and the S&P 500 returnsThere are a few things to consider from this, however. Although returns don’t look exceptional different, there were a few non-geopolitical events that happened over these periods. For example, the Great Financial Crisis occurred during the Iraq war timeline. The market rallied for years after the start of the war — climbing over 93 per cent or 15.6 per cent per year before succumbing to that calamity. The Vietnam War bracketed the period of the 1973 oil crisis that went from October 1973 to March 1974. During this period the market fell as much as 15 per cent. The wars themselves were not the cause of mediocre returns — it was economic shocks that created the most damage. It is also worth noting that most geopolitical events don’t materialise into full-blown wars. According to findings by LPL Research, “.. the S&P 500 fell 5 per cent on average in 20 major geopolitical events dating back to the attack on Pearl Harbor in 1941. However, the S&P 500 recovered those losses in fewer than 50 calendar days on average.” Minor in the grand scheme of things, especially for long term investors. The events they cover include items like the Cuban Missile Crisis and the recent Saudi Aramco Drone Strike. Since no one knows with any real degree of certainty what the outcome of most geopolitical events, especially military escalations, it is generally not worth materially altering your investment plan. In my opinion, an overreaction could be far more costly than actually staying the course. The latest Iran conflict is likely to be no different.I’ll end with a story by the legendary trader, Art Cashin and retold by Barry Ritholtz:“ … it was the Cuban Missile Crisis and there were rumours that Russia had launched rockets and the Dow took a dive near the bell. I cleaned up my desk and raced to the Moosehead, as animated as only an 18-year-old can be. Jack was already there and as I burst through the door, I shouted: “Jack! Jack, there was a strong rumour that the missiles were flying and I tried to sell the market but failed.”Jack said “Calm down kid! First buy me a drink and then sit down and listen to me.” I ordered the drink and meekly sat down.Jack said — “Look kid, if you hear the missiles are flying, you buy them. You don’t sell them.”“You buy them?” I said, somewhat puzzled.“Sure you buy them!” said Jack. “Cause if you’re wrong, the trade will never clear. We’ll all be dead.’”Sources:• “Stocks More Than Doubled Over the Last Decade. Many Investors Missed Out” by Julie Segal, Institutional Investor, January 9 2020. https://tinyurl.com/vufkho5• “How Stocks Do During Geopolitical Events”, Posted by LPL Financial Research, January 8 2020. https://tinyurl.com/v8tdh48• “Cashin on the Cuban Missile Crisis / North Korea” by Barry Ritholtz. August 14 2017. https://tinyurl.com/t3m7usn • Nathan Kowalski CPA, CA, CFA, CIM, FCSI is the Chief Financial Officer of Anchor Investment Management Ltd. and can be contacted at nkowalski@anchor.bm. Disclaimer: The sole responsibility for the content of this article lies with the author. It does not necessarily reflect the opinion, policy or position of Anchor Investment Management Ltd. The content of this article is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy or for any other purpose. The information and opinions contained in this material are derived from proprietary and non-proprietary sources deemed by the author to be reliable. They are not necessarily all-inclusive, are not guaranteed as to the accuracy and are current only at the time written. Past performance is no guarantee of future results. There is no guarantee that any forecasts made will come to pass. Reliance upon information in this material is at the sole discretion of the reader. Investment involves risks. Readers should consult their professional financial advisers prior to any investment decision. The author may own securities discussed in this article. Index performance is shown for illustrative purposes only. You cannot invest directly in an index. The author respects the intellectual property rights of others. Trademark or copyright claims should be directed to the author by e-mail.