Thursday, 10 August 2017

Finance: The market's reaction to North Korea this week is historically unusual

North Korean leader Kim Jong Un

Napoleon defined "military genius" as "a man who can do the average thing when all those around him are going crazy." The same can be said of investing.

  • Recent incendiary comments from Donald Trump and North Korea have spooked investors, but stocks haven't fallen too severely.
  • That's somewhat unusual when looking at market reactions to geopolitical events since WWII.
  • As always, it's worth reiterating that stocks generally go up, even after geopolitical shocks.

Geopolitical anxiety has picked up in recent days amid ongoing elevated tensions between the United States and North Korea.

But even though incendiary comments from both US President Donald Trump and North Korea have spooked investors (and everybody else), markets haven't seen a huge drop yet.

South Korea's markets have seen most of the action, with the won trickling down and the benchmark Kospi stock index falling by a "minor" 1.5% this week. Meanwhile, traditionally safe-haven trades like the US dollar, the yen, and gold have picked up a bit, but not significantly.

That relative lack of movement is unusual compared to past market reactions to geopolitical events after World War II, according to John Normand, the Head of FX, Commodities, and International Rates Research at JP Morgan.

Normand looked for patterns among major geopolitical events since World War II (starting with the Korean War and ending with Brexit) and outlined a few conclusions in a recent note to clients.

Chief among them, he writes that "short-term market reactions to geopolitical stress can be huge, even if retracements occur within a few weeks or months," and that volatility jumped "materially" for all asset classes before a given event. Here are his main findings for different asset classes:

  • There's variation when it comes to stocks: Some episodes like the Korean War, the Cuban Missile Crisis, and September 11 saw equities initially drop by 5-8%, while other developments saw little reaction.
  • On average, yields have tended to drop 10 basis points in the month leading up to the event and by 5 basis points in the month following it.
  • Oil and other commodities tended to jump by an average of 5% in the weeks leading up to event — in particular during events that involve oil producers.
  • Gold also tended to jump ahead of an event and then sell off afterwards, while currencies have seen mixed results.

"If the main takeaway is that geopolitics drives volatility rather than trend — unless an oil producer enters the mix and recession ensues — then the most unusual development this week may be the relative market calm amidst apparently high anxiety," Normand said (emphasis ours).

"Maybe market participants realize that North Korea has generated many false alarms over the past decade, so are reflexively reaching for the snooze button," he continued. "Or maybe they struggle to equate stronger rhetoric with actual conflict given the protagonists."

In the long run, stocks usually go up

It's worth noting, as always, that although emotional responses to geopolitical shocks are quite typical of investor behavior, history has shown time and again that these events generally don't have a sustained impact on markets.

Reviewing data on major geopolitical events in the past 100-plus years, Credit Suisse's former head of research and deputy global CIO Giles Keating and his team found in 2015 that stocks generally bounced back after such shocks.

"The large majority of individual major events — ranging from the assassination of Archduke Ferdinand 100 years ago through to 9/11 and recent events in Iraq and Ukraine — impact major stock markets by around 10% or less, with the effect being fully reversed within a month or so," he wrote in a note to clients.

"This suggests that the most profitable strategy has usually been the contrarian one of buying into price falls caused by such incidents."

Warren Buffett has also championed this stay-calm-when-all-hell-breaks-loose strategy. At the height of the financial crisis, in October 2008, Buffett wrote in a New York Times op-ed article:

"Over the long term, the stock market news will be good. In the 20th century, the United States endured two world wars and other traumatic and expensive military conflicts; the Depression; a dozen or so recessions and financial panics; oil shocks; a flu epidemic; and the resignation of a disgraced president. Yet the Dow rose from 66 to 11,497."

As a final note, outside the world of markets, France's Napoleon had a similar strategy of staying rational when others are panicking. He defined "military genius" as "a man who can do the average thing when all those around him are going crazy." Some have pointed out the same can be said of investing.



from pulse.ng - Nigeria's entertainment & lifestyle platform online

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