November 17, 2015

How do major geopolitical disasters and acts of violence play into the world’s financial markets? Does every act of terrorism, like most recently in Paris, make significant dents to the markets and investors? Each war from the World Wars to the Cold War have taught investors very different lessons. The important thing to remember is that the experience from the last war could have “limited relevance” to the next. WWI was not anticipated in 1914, whereas WWII was and the economic behavior was very different for both. If WWI had been anticipated the majority of investors would have moved assets out of the UK and into the US before 1913-14, which would have saved many from heavy financial damage. WWII was fully expected and many investors who viewed themselves as wizened from WWI moved their assets from the UK into the US. However, UK assets consistently outperformed US assets during WWII. As you can see, trying to copy investment strategies from history will often leave the investor or student frustrated, because there is no “ideal” strategy for every political conflict.

In relevance to today’s geopolitical landscape, Niall Ferguson a Professor of History at Harvard, discusses how the “War on Terror“, that began after 9/11 when we were introduced to al Queda and radical Islamic groups appropriately nicknamed the “Islamofascists”, affected the stock market:

“Throughout this period of heightened terrorist threats and overseas military interventions, financial markets appear to have displayed a remarkable insouciance about political risk. The U.S. stock market was affected only momentarily by the attacks of 9/11. True, between September 10 and September 21, 2001, the Dow Jones Industrial Average declined by as much as 14 percent. Within just over two months, however, the Dow had regained its pre-9/11 level. And although 2002 was a disappointing year for U.S. equity investors, the market surged ahead thereafter, exceeding its previous peak (at the height of the “dot-com” mania) in the fall of 2006. By October 9, 2007, the Dow stood at nearly double the level it had reached in the trough five years before.”

Interestingly enough, just 6 years after 9/11 the US market did fall into financial crises but not because of the escalation of violence in the Middle East- that happened between Lebanon and and Iraq in 2006. The slip into a frightening financial abyss similar to the Great Depression was thanks to defaults in the U.S. subprime mortgage market. Based on this evidence, geopolitical unrest and war are not always the lead killers of financial markets. A combination of excessive borrowing, risky investments, and lack of transparency by financial institutions did more damage than any war. There is no instruction manual, even with what we have learned from history, that will keep every investor safe from volatility in the markets.

Currently we are stuck in a deflationary environment post 2008 with low interest rates and the price of oil has dropped over 60% since June 2014. The current enemy is ISIL (radical Islam) and their recent attack on France, one of our oldest allies, has frightened many of the fragility of the Western world, but as of today both European and US markets are not giving into the same fear.

If you want to learn more about these topics, please read here http://www.brookings.edu/~/media/Projects/BPEA/Spring-2008/2008a_bpea_ferguson.PDF