Special Topic: Geopolitical Tensions Continue
In late April this year we sent out an update regarding the heightened geopolitical tensions between the United States of America (the US) and Syria, and the rise in tensions between the US and North Korea (NK). The update discussed the possible impact the conflicts could have on your portfolio.
Tensions have continued to rise in recent months with a new war of words breaking out between the US and NK. Despite UN sanctions supposedly enforced as an attempt to turn NK away from advancing its nuclear capabilities, the East Asian nation has continued to carry out tests, including hydrogen bomb tests.
In response, President Trump threatened to “totally destroy” North Korea, and that NK leader Kim Jong- un and Foreign Minister Ri Yong- ho “won’t be around much longer” – words that the NK constituents took as a declaration of war. Yong- ho retaliated, speaking about US aircraft flying close to the Korean Peninsula, suggesting that their rights included shooting down the aircraft even if it is outside North Korean airspace.
Although the two sides have been at opposing ends of this conflict for decades, this intensity of threats and provocations between the two sides has escalated dramatically in recent times. Markets have not really reacted to the news and any preliminary concerns have been short-lived, with investors quick to move on.
History as a guide
There is no single guide that explains to us how markets would react in the event of break out of war. Historically, in worst case scenarios (wars), falls in the markets have been anywhere from small to substantial, accompanied with volatility. In some cases markets have rebounded quickly and in other situations the bounce back has taken substantially longer. In general, investors would expect to see a decline in equity markets and a rotation into safe havens such as government bonds or gold.
Data from AMP indicates that US shares fell between -7% and -34% during six major conflicts, with the largest fall attributed to World War 2. In all of these cases, the market had recouped its losses 6 – 12 months after the low. Markets tended to fall once war broke out and tended to bottom prior to a resolution. The extent of the decline was also dependent on the market environment at the time.
With no clear historical precedent it is worth assessing the current market environment for some insight on the potential way forward. The current geopolitical unrest is occurring during a period when central banks are removing stimulatory policies and favouring rate hikes, which leaves markets more vulnerable to a pullback if a large negative event happens to unfold. However, in general central bankers have reaffirmed a commitment to step back in to support the market in the event of a large disruption to markets or the global economy.
After a very strong year for markets, it would not be out of the question for a pullback sometime soon – however predicting when and why remains beyond the control of all investors. The factors which investors can control are their risk profile and asset allocation. An appropriately diversified portfolio can partially insulate investors from a market decline or at least minimise volatility to the extent that the investor remains committed to their long term investment strategy. William Buck has ensured that your portfolio is appropriately diversified, given your risk profile
Nobody can ever be certain of the outcome in financial markets, particularly when military conflict in involved. At present there are no signs that the US is preparing for a conflict given there have been no specific military deployments. This means there is still a possibility that the tension could de-escalate once again. However given North Koreas growing nuclear capability and the unpredictability of both leaders, a miscalculation from either side that has the potential to lead to conflict should not be ruled out.
We will continue to monitor the situation and update you appropriately. We anticipate that, given it is not in the interest of either side to engage in full- blown conflict, diplomacy will prevail and that a peaceful solution can be reached.