News analysis

Markets learning to look beyond military flare-ups

Iran's missile attack on US army bases in Iraq on Wednesday sent gold blasting above US$1,600 an ounce. But it took just hours for that safe haven dash to fade and for global stocks to rise again.
Iran's missile attack on US army bases in Iraq on Wednesday sent gold blasting above US$1,600 an ounce. But it took just hours for that safe haven dash to fade and for global stocks to rise again. PHOTO: EPA-EFE

Hardened by crisis after crisis, investors now view selloffs as a buying opportunity

LONDON • Iran's missile attack on US army bases in Iraq on Wednesday sent gold blasting above US$1,600 an ounce, boosted the Japanese yen by almost 1 per cent and oil by US$3 a barrel.

But it took just hours for that safe haven dash to fade and for global stocks to resume their climb.

It was the second volte face in under a week following a similar pattern of events after the US' killing of top Iranian commander Qassem Soleimani on Jan 3. And that mirrored a super-fast round trip on markets after Iran-backed rebels attacked Saudi oil facilities last September.

Welcome to the brave new world where it appears that little short of full-fledged world war between nuclear-armed powers would be required to have a durable impact on financial markets. And even then, some begin to wonder.

By the European close on Wednesday, Brent crude oil prices had returned to below levels seen before Major-General Soleimani's death and Wall Street's S&P500 equity index rallied to new record highs.

Regionally-contained military blow-ups and bursts of conflict have proven in recent years not to have a durable impact on either oil supplies and prices nor global economic activity.

Even September's attacks on Saudi oil installations had no lasting effect on crude prices. And years of North Korean nuclear tests and missile launches have not affected international investment patterns for any significant length of time.

So traders and investors are betting as much on repeated patterns of behaviour rather than on amateur geopolitical reasoning.

"The market has taken a view based on a decade's worth of experience that this is not going to escalate out of control," said Societe Generale strategist Kit Juckes. "It's the same with the economy. We've had an economic cycle with mini-cycles since 2008 but no recession, we've had trade wars that haven't really turned into real trade wars but keep getting postponed."

And investors who stuck with equities and looked past euro debt crises, North Korean missile tests, Arab Spring revolts, trade wars, Middle East turmoil and unconventional economic policies, have reaped rich returns - world stocks have added more than US$25 trillion (S$34 trillion) in value since 2010.

A geopolitical risk index compiled by US Federal Reserve Board researchers rates the Saudi attacks at a relatively high 185 points, but well below the 2003 US invasion of Iraq that scored 545 points.

For decades, the energy price impact has been the main transmission mechanism from major conflicts - particularly in the Gulf - to the wider economy and world markets. The threat of oil supply disruption has been a shadow on the global economy ever since a quadrupling of oil prices during the 1973 Opec oil embargo and a 30 per cent jump in 1990.

But oil spikes these days tend to be briefer. That partly reflects the changing nature of energy usage and geographical sources of supplies. US shale oil producers can now step up to offset price spikes stemming from Gulf supply disruptions, regardless of local politics or Opec action, while the rise of renewable energy sources amid fears of climate change is happening at a rapid pace.

Of course, wars and invasions have driven big market shifts in the past, causing mini-panics and safe-asset buying on fears for business confidence, trade and energy prices. But the experience over recent decades has been that, all things being equal, markets tend to recover quickly and portfolio managers with the stomach to see through short-term lurches do well, even without expensive hedging.

Schroders noted that during periods of extreme risk, a portfolio of "safe" assets comprising bonds and gold usually outperformed "riskier" equities. But it also found that in all these instances, shares recovered within months, suggesting that "if investors are willing or able to ignore volatility, then investing in the risky portfolio represents a better strategy than a safe portfolio".

The market context itself has also changed - most prominently by years of near-zero interest rates and central bank money printing that have inflated prices of high-quality bonds, reduced benchmark borrowing costs and cut what is available to investors.

Shares, meanwhile, have been pumped up by buybacks and abundant private funding that have reduced equity supply over the years. With JPMorgan predicting equity supply to fall by a further US$200 billion this year, many investors have come to view selloffs as a buying opportunity.

"The demand-supply nature of markets has completely changed," said Mr Salman Ahmed, chief investment strategist at Lombard Odier. "Central banks have reduced the supply of safe assets and that's rippled out to risky assets. It's a very powerful force."

REUTERS

A version of this article appeared in the print edition of The Straits Times on January 11, 2020, with the headline 'Markets learning to look beyond military flare-ups'. Print Edition | Subscribe