However, despite these ‘hot spots’ there appears to have been a surprisingly muted direct response from overall equity markets.The recent sell-offs in the market have been driven by a sentiment of overvaluation rather than triggered by a single geo-political event. Even the increasing instability in the Middle East seems, at least up to now, to have had little impact.
On that basis, is it reasonable to pose the question: ‘do geo-political events still have the ability to have the same impact on equity markets as they used to, and if not, why not?’ As is usual with such questions, the answer is not a simple one.
By their very nature, geo-political events are often unpredictable and can arise (and subside) relatively quickly and sometimes without much warning. Hence, the more dramatic and the more unexpected the event, the more severe the short-term market reaction tends to be.
Conversely, the faster they are resolved or absorbed, the more transitory is the effect on equity markets.
A good example of this is the dramatic events surrounding 9/11 and its immediate aftermath in 2001. The initial attacks resulted in a sharp initial retreat in global equities, but this had been reversed by the end of 2001.
The longer-term impact resulting from the sea-change in American policy, however, had a less dramatic on-going impact on markets.
Performance of MSCI World after 9/11 attacks
Source: FE Analytics
In essence therefore, what has to be borne in mind is that geo-political events in themselves rarely change the primary trend of markets and, in that sense, their overall impact is often relatively short term and transitory in nature within a broader cyclical, or secular, trend.
Turning back to the original question posed earlier, the following may help explain some of the reasons why recent geo-political events have seemingly been shrugged off by equity markets:
1. In this continued period of extremely low interest rates and accommodative central bank policy, any pull-back in equity markets has been seized upon as an opportunity to buy.
This may have lessened the short-term widespread downside pressure, although it may affect markets on a more localised basis (such as the current Hong Kong unrest).
2. Many of the current geo-political events are so complex that many investors, including seasoned ones, are either wearied by them or are just thoroughly confused about how many of these issues can be resolved.
On that basis, such issues have tended to be treated as ongoing problems that can be only be addressed over a medium/longer-term period.
For example, looking at the current situation in Syria and Iraq, it is difficult to know who is fighting whom or who one’s enemies or allies are. In such an environment decision making can almost come to a halt or move, at best, by osmosis.
3. The pressure/volatility has been absorbed more by other asset classes such as currencies and fixed income. In particular, currencies have seen some greater volatility recently, suggesting much of the strain may have been taken by them.
The point about other asset classes taking the strain is particularly interesting.
Clearly, the US dollar remains the ‘safe haven’ currency and so some of its recent strength may be due to this factor, although it may just as well be the result of increasing confidence in the economic recovery that has taken hold in the US that will likely lead to higher interest rates within the next 12 months.
The action and direction of fixed income yields has also been of note since, until recently, fixed income in the US and the UK have performed well despite the prospect of looming interest rate rises in these Anglo-Saxon economies.
Whilst this seemingly perverse movement may be down to simply a disbelief in the strength of global economic recovery, it is possible that, at least in some measure, investors wary of geo-political problems have used fixed income as a ‘bolt hole’ rather than gold, which has performed relatively poorly in recent months.
In essence, geo-political factors have helped to dampen, or mask, more fundamental analysis, particularly in the fixed income arena.
In this complicated geo-political and economic environment, it may be that investor concerns are being dissipated through other asset classes more than would be the case in ‘normal’ circumstances. If that is the case, then, for equity investors, the geo-political part of the equation may currently be relatively benign.
However, nothing is forever and therefore, as we move gradually back to economic normality then, for equity investors, these geo-political forces are likely to reassert, with the inevitable increased volatility that this will entail.
David Thomas (pictured top of page 1) is managing director at Thomas Miller Investment. The views expressed above are his own.
