The United States’ airstrike January 3, 2020, near Baghdad, Iraq, that killed a top Iranian military general heightened tensions in the Middle East. Iran’s retaliatory strike January 8 sent a message. Certainly, additional responses cannot be ruled out. In fact, further action is likely, but suggesting we might be on the brink of World War III was a stretch. What does this conflict mean for stocks?
These latest developments understandably put many investors on edge. It is often a difficult task to separate the human toll from the economic and financial toll—never easy when lives are lost in times of geopolitical conflict. For investors, the good news is the stock market has a long history of shrugging off significant and unsettling geopolitical events. For now, the market response has been consistent with experience. If market participants determine that occurrences such as this one do not have much impact on U.S. economic fundamentals or corporate profits, the resulting stock market volatility may be fleeting, as was the case here.
According to a study by Sam Stovall at CFRA of 20 geopolitical events dating back to World War II, stocks have fully recovered losses within 47 calendar days after an average maximum loss of 5%. This study includes the recent drone attack on the Saudi oil fields (19 days for the Dow Jones Industrials to decline 4.0%, 41 days to recover); the 9/11 terrorist attacks (11 days to decline 11.6%, 31 to recover); the Kennedy Assassination (1 day to decline 2.9%, 1 day to recover); and the devastating Pearl Harbor Attack (143 days to decline 19.8%, 305 days to recover). The stock market’s track record of recovering quickly from many of these events can be reassuring. Consequently, we do not want to overstate the potential of geopolitical events, no matter how unsettling they might be. Unfortunately, geopolitical stability in the Middle East region has always been temporary. Fortunately, neither side wants an all-out war.
The S&P 500 Index has increased more than 10% since the start of the fourth quarter of 2019 which means investors priced in a lot of good news late last year—a U.S.-China trade deal, stabilizing global growth, and the pause in Federal Reserve (Fed) rate hikes. Some potential 2020 gains have probably been pulled forward into late 2019, perhaps limiting the upside for 2020. Regardless of how the Iran conflict plays out, we may see stocks get repriced over the next several months as investors wait for the economy and for corporations to deliver against the lofty expectations that are accompanying higher stock prices. The wait for the fundamental improvement that has been priced in could be accompanied by increased market volatility. Bull markets historically have tended to include several pullbacks of 5–10% in a typical year.
While heightened geopolitical uncertainty can be unsettling for investors, it is advisable to focus on the fundamentals supporting gross domestic product, inflation, employment, interest rates, and corporate profits when making investment decisions. Since stocks have weathered geopolitical tensions in the past, we would not be sellers of stocks into weakness related to the U.S.-Iran conflict. A focus on fundamentals served us well last year, and we believe it will again in 2020.
The views expressed are provided for information only and are not to be used or considered as an offer or solicitation to buy or sell securities or investment products. To determine which investment(s) may be appropriate for you consult your financial advisor.
The economic forecast set forth in this presentation may not develop as predicted, and there can be no guarantee that strategies promoted will be successful.
Data provided by LPL Financial and Sam Stovall.
All investing involves risk including loss of principal.
All indices are unmanaged and cannot be invested into directly.