Many geopolitical events are shrugged off fairly quickly, an IMF report shows.
Markets are having another bout of nerves after Israel bombed Iran, which is believed to have fired back drones in response.
But already there are signs that investors' geopolitical angst may have peaked. S&P 500 futures (ES00) are off session lows and oil prices (CL.1) have nearly cut in half their earlier spike.
For those investors fortunate enough not to be directly impacted by the conflict the reaction is, given past events, understandable.
"Financial markets are always incredibly quick to price in geopolitical fear, but tend to be equally quick to discount it again, seeing the risk premium fade in short order," says Michael Brown, senior research strategist at Pepperstone.
A report by the International Monetary Fund, released in April, shows that mostly to be true, though countries and sectors obviously can react differently depending on their proximity and/or sensitivity to the conflict.
"Stock prices have generally had a modest reaction to geopolitical risk events, but major events - especially military conflicts - have a disproportionally larger and more persistent effect on asset prices," say the IMF researchers Salih Fendoglu, Mahvash S. Qureshi, and Felix Suntheim.
They looked at the frequency of news stories as a guide to the heft of geopolitical events and found that the average monthly drop for stocks is about 1 percentage point across countries, though it's a fall of 2.5% for emerging markets.
Source: IMF
"Of the different types of major geopolitical risk events, international military conflicts hit emerging market stocks the hardest, likely because of more severe economic disruptions compared with other events. In these cases, the average monthly drop in stock returns is a significant 5 percentage points, twice as much as for all other types of events," says the IMF team.
The good news is that average stock market returns after major global geopolitical risks usually turn positive after just a month. But that can depend on the conflict's characteristics and it's varying impacts on asset classes, sectors and countries.
"For example, supply-chain disruptions may increase commodity prices but decrease stock prices if the disruptions are expected to have an adverse effect on economic activity. Differences may also arise across sectors: for example, the energy sector may benefit if supply-chain disruptions raise oil prices, whereas energy-dependent sectors are likely to suffer in such a case," says the IMF.
Concerns about crimped oil supply linked to a conflict, as is the case was Friday, can produce more prolonged negative market reactions. Iraq's invasion of Kuwait saw the S&P 500 SPX post real negative returns for six months, for example, while the 1973 oil embargo saw the S&P 500 deliver negative real returns of more than 60% after several months.
Deutsche Bank, in a note published last year, provided a more detailed table of S&P 500 reactions to major geopolitical events. It seems to suggest that the stock market has of late become better able to absorb such tensions.
S&P 500 gains/losses following major geopolitical events
"Geopolitical events have often created short, sharp market shocks, but with little lasting impact beyond weeks," says the Deutsche team led by strategist Jim Reid. After the initial anxiety dies down the macroeconomic drivers take back control.
"So on this basis you should generally buy into geopolitical risk," says Deutsche. But they add: "The question is whether we're entering a new phase given that tensions are rising, or whether geopolitical risk continues to create more fear than reality."
