The Market's Heartless

Writing about investing during wartime always feels a bit icky.

The day to day gyrations of the stock market feel incredibly unimportant when the human cost of what is going on in the Middle East ramps ever higher. The world feels a very fragmented and frightening place.

But, I do get asked about the implications for markets, and it is my job to have a decent answer - so here we are.

Usual rules apply, none of us (least of all me) can possibly know how the situation is going to develop from here.

All we can do is lean on what history tells us about how this might play out for investors.

At the end of 2023, JP Morgan published some excellent research on how the S&P has performed during past geopolitical conflicts.

They found that although short term performance for the market was worse than average in the immediate aftermath of said event, 6 and 12 month returns were bang in line with their long run averages.

List of said geopolitical conflicts. Source: Ned Davis Research, JP Morgan Private Bank.

In other words, if investors can ride out the initial storm following an outbreak of war then things tend to blow over pretty quickly for markets.

Averages, by definition, cover a whole range of outcomes of course. But similar research by MSCI, which strips out the performance of both global equity markets and the VIX Volatility Index during individual instances of war since 1990, tells a similar story.

Source: JP Morgan Private Bank, Robert Shiller, Haver Analytics. Returns are shown for the S&P 500 in USD terms, inflation adjusted. Price only.

Here I’m less interested in the blue line (equity market performance) than the orange (market volatility/fear levels).

What we see is that at the outbreak of a conflict volatility spikes and then usually falls back away sharpish. The exception being the Georgian War, which just so happened to take place alongside the Global Financial Crisis.

This again suggests that any disruption to markets from current events would be fairly short lived.

So far, this time around, investors have pretty much shrugged this conflict off. I was exchanging messages with a mate on Sunday, and we both expected markets to open down a couple of points on Monday. Neither of us expected them to be in the green.

Source: Substack

But that’s exactly what happened. Yet another reminder, if it were needed, that nobody knows anything really. It is pointless trying to guess.

There is every chance that this thing escalates beyond where it is at the moment, beyond the tragedy that we have already seen, with significant economic implication.

Much has been written about the strategic significance of the Strait of Hormuz, its importance to global trade. Roughly 20% of the global supply of oil passes through this shipping lane, and Western Europe can ill afford another inflationary shock so recently after Russia’s invasion of Ukraine.

But for now, things seem to have calmed down a little. Iranian retaliation so far, regarded as relatively muted.

And this is the final point I want to make. Markets constantly move based on outcomes relative to expectations. Where the market’s expectations are move day to day, hour by hour, fraction of a second to fraction of a second. We cannot and will not ever know where this invisible benchmark sits in real-time.

Because of these ever shifting expectations, we can end up with an outcome where Iran launching missile strikes against a US air base in Qatar is thought of as a “best case” scenario. Three months ago, those headlines would have been catastrophic.

But the world moves on along with that invisible line, and we lose our capacity to become surprised by events that would have once been thought of as shocking.

Right now though, our attention as human beings cannot move on. We cannot look away. We must hope and pray that cooler heads prevail, as they have done before.