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Observers can be forgiven as the thinking that financial markets do not give much to geopolitical shocks. The largest economy in the world is in danger of placing itself behind a tariff wall. War is raging in Europe. And since June 13 a fresh conflict has broken out in the middle east. Nevertheless, the S&P 500 remains near record highs. It has been resilient this week, even when the US considered joining Iran at Israel’s war. Brent rough prices have risen, but only to a tame $ 77 per barrel. Have investors lost contact with reality? A look at historic market reactions on worldwide events does not suggest.
With the help of data that goes back to the Second World War, Deutsche Bank discovers that the S&P 500 tends on average to fall around 6 percent in the three weeks after a geopolitical shock, but to recover completely three weeks later. In other words, if history is a guide, there is still time for the market reaction to the Israel-Iran conflict to evolve.
Each shock also manifests itself in different ways. Adolf Hitler’s annexation of Czechoslovakia in 1939 led to a 20 percent crash in the most important US stock index. That took more than a month to the bottom. The 9/11 attacks led to a sale of more than 10 percent in just six days that recovered in three weeks. The 1973 OlieMbargo by Arab countries after the Jom Kippur War led to an inflation crisis from which developed markets lasted for years to recover. The high dependence on Europe of Russian gas meant that the industries were impeded for a long period by high costs after Vladimir Putin invaded Ukraine in February 2022. The Dax index of Germany continued to go down until October that year.
What can we learn from these events? The market reaction usually comes from two parts. First, the trust of the shock buffets investors, which burns a flight to safety. Secondly, depending on the economic significance of the event, it ultimately seeps into profit, investment plans, prices and jobs, so that traders are subsequently brought to the price in a changed economic prospect.
At the moment, confronted with both the rate and the middle East, investors are trying to determine their effects on the real economy. The sharp initial sale caused by the ‘Liberation Day’ tasks of Donald Trump was only removed by a 90-day break in his enforcement. That deadline rose on July 8, with little clarity about what happens next.
Regarding the Israel-Iran war, the more subdued immediate response, at least compared to historical energy shocks, makes sense. Oil is less important in feeding the global economy than in the 1970s. The range is also less concentrated. Iran’s oil export is good for less than 2 percent of global demand, and in 2020 the US became an annual net exportor of total petroleum for the first time since at least 1949.
This has the spirit of investors aimed at what is most important for the world economy of the crisis. The greatest risk is an escalation, possibly with the US entering the conflict, which leads to the closure of the Strait of Hormuz, which means that one fifth of the daily oil consumption flows. If that happened, analysts could think that oil could push over $ 120 per barrel. A temporary price shock could then be in more persistent inflation, with knock-on implications for central banks.
As a result, traders are carefully examined to view developments at both rates and the war in the Middle East, so that probabilities for sausage-case scenarios are calibrated in real time. Only when the uncertainty cleans up can investors correctly reassess their predictions for economic foundations, which underlie the valuations of assets. For now, however, July 9 remains a big unknown. And although President Trump appeared on Thursday to give time for negotiation with Iran, as he previously warned: “Nobody knows what I’m going to do”. Despite recent performances, geopolitics is important for markets – as soon as this influences the real economy. Today it can prove to be the relative calm for the storm.
