This Geopolitical Crisis Isn’t Like The Others

This Geopolitical Crisis Isn’t Like The Others
Stéphane Renevier, CFA

about 2 years ago2 mins

As you can see from the table above, the stock market has tended to react pretty mildly to past geopolitical shocks. The overall picture is quite clear: markets have dropped more than 10% on only four out of 22 occasions, and took about two months to recover on average. So why have four events led to major losses, while all the others left markets unfazed?

I’d suggest two reasons: the overall macroeconomic backdrop at the time, and the link between the shock and US company profits. Take the killing of a top Iranian general in 2020: it was a significant geopolitical event, but it didn’t present a direct threat to US firms. Keep in mind too that the Fed was in the middle of very accommodative rate cuts, which reassured investors that any negative economic impact would promptly be offset by central bank support. In short, it didn’t get investors too worked up.

Iraq’s invasion of Kuwait was different: it caused the oil price to double, and got investors worried that high inflation could threaten companies’ profits. That led to a total drawdown of almost 17%. But even then, the Federal Reserve (the Fed) had plenty of room to cut interest rates, which it took advantage of a total of six times in the following few months. That ultimately reassured markets and softened the economic blow.

No such luck today. Like the Kuwait invasion, the Ukraine-Russia crisis – which threatens the supply of raw materials – is a direct risk to US company profits and inflation. But unlike the Kuwait invasion, interest rates are already at record lows, meaning the Fed has very little room to cut them lower and limit the potential economic damage. All that, just as the US stock market reaches its all-time valuation record. So you can understand why some investors are more nervous this time around…

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