From the Desk of Risk: What Would Mideast Conflict Mean for Markets?
Let me set the stage. The price of oil is up over 7.5% in the past month. We’re looking at the beginning of the end of quantitative easing in the United States and the consequent rise of interest rates. Escalating mortgage rates could frighten potential homeowners back into renting. We have a raging (as well as politicized) debate as to who should be our next Fed chair. Financial markets and currencies from many emerging economies are hitting the wall. The U.S. government is about to enter a protracted debt-ceiling debate. And, as if this is not enough, we now have a possible U.S. intervention in the Mideast that could rattle worldwide financial markets. The winds of war may breach any national border.
With this backdrop in mind, the question we must pose is this:
Setting aside the moral, ethical, and political conundrums of a U.S. intervention in Syria, how should we expect financial markets to react when conflict in the Mideast flares up?
In attempting to answer this question, the table below lists the notable Mideast conflicts during the past 50 years along with the S&P 500 returns around the time of these events.
(Click for detail)
What’s notable from the above table is that while there is weak evidence of negative market reactions in either the run-up to or the commencement of a Mideast conflict, none of the start-date losses have exceeded two percent. In fact, the total loss during the conflict period has never been in excess of three percent. It is also very difficult to isolate the “conflict portion” of the return from general economic conditions and coincident events. Many of the worst losses occurred during recession.
The dangers with any Mideast conflict are quagmire (neither the U.S. people nor the government have the stomach for a protracted conflict), escalation (definitely a heightened risk given the chances that Syria or its allies will counterstrike against Israel), and oil-price spikes (already happening in anticipation, though it’s been gradual and measured).
Neither the U.S. public nor either political party has the stomach for an extended conflict. It is also doubtful that the Assad regime would threaten its own existence through meaningful escalation. Regarding any oil-price shocks, it is not in Saudi Arabia’s interest to allow oil prices to reach the tipping point to derail economic growth. During the Libya conflict, the Saudis openly discussed the need to constrain oil prices. And they are likewise no friend of Syria’s Assad.
In sum, while we have plenty of reasons to be concerned with how events will play out during and after a U.S.-led strike against Syria, it’s likely that the cumulative impact of domestic events will have a greater impact on U.S. financial markets.
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