Airstrikes in Syria, warnings of an ISIS attack at home, ongoing tensions with Russia: Geopolitical risks have clearly been rising … and yet the stock market has not fallen far from its record highs.
Yes, the S&P 500 had its worst day since early August on Monday and continued its slide for a third straight session on Tuesday. But the weakness may have been caused by concerns about economic growth in China and Europe as much as by worries about the Middle East. Volatility has picked up, but none of the major indices has suffered large cumulative losses over the last month, with the Dow Jones Industrial Average up slightly, while the S&P 500 and the Nasdaq are down a fraction of a percentage point. Oil futures are near multi-year lows below $100 a barrel.
“Financial markets have remained largely impervious to politically generated turmoil this year,” Tina Fordham, chief global political analyst at Citi, wrote in an attention-grabbing research note on Tuesday. Investors, she said, have been “seemingly unconcerned with ISIS as long as it does not openly destroy oil refineries, and with the Russia-Ukraine conflict as long as a NATO member state is not attacked.”
Why haven’t those global headlines put more of a scare into the stock market? Fordham chalks it up to the power of “cheap money” from central banks supporting asset prices and the revolution in energy markets caused by the U.S. shale boom. On top of that, investors have a heavy focus on the U.S. equity market, which accounts for half of global market capitalization even as it only represents 22 percent of global GDP and 6 percent of the world’s population. That has all led investors to largely dismiss the geopolitical risks as localized dangers rather than more broadly systemic ones that could affect the U.S. economy and corporate earnings.
Historically, geopolitical risks have impacted markets through one of two transmission mechanisms: a growth shock or an oil price shock — or both, as in the 1973 crisis. Today, central bank support has limited the impact of disappointing growth on markets, and the emergence of US shale has muted the impact of an oil price shock, raising the question of whether markets have outsourced geopolitical risks to central banks.
Surging energy production in the U.S. has significantly reduced the reliance on foreign oil; from August 2006 to June 2014, net crude imports dropped by 8.7 million barrels a day, “equivalent to the oil exports of Saudi Arabia plus Nigeria,” according to Fordham.
At the same time, there’s no guarantee that the market will remain calm about the conflicts, especially if they disrupt economic activity more than they already have — and especially as the Federal Reserve ends its bond-buying stimulus and signals the eventual start of interest rate hikes. On that front, renewed tensions with Russia might still be more worrisome than a renewed military presence in Iraq or airstrikes in Syria.
“Fed tightening clearly represents an important test for global financial markets,” Fordham says. “It could trigger increased market volatility. And if this were to occur at a time when shale oil production is less able to dampen volatility in the oil price then finally global investors might be forced to take real notice of recent worrying geopolitical developments.”
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