Edited by Vani Rao
Will human tragedy determine long-term impact on financial markets?
On July 17, 2014, at around 4:20 pm, a Malaysian 777 aircraft carrying 295 passengers and crew disappeared over the east Ukrainian air space, a few miles from the Russian border. It disappeared in virtually the same location as the Ukrainian military transport AN-26 aircraft, which was shot down by a missile a few days before.
Ukrainian officials said the aircraft might have been shot down, possibly by a Russian-made anti-aircraft system. The incident was the latest in a series of tensions between Ukraine and Russia that has resulted in clashes along the border, including the targeting of military aircraft. If that proves to be the case, it would mark another dark turn in one of the world’s most volatile geopolitical hot spots.
Recently, dormant concerns over Ukraine were already edging back into traders’ field of vision after Russian President Vladimir Putin hinted at retaliation against US firms following Washington’s announcement of fresh sanctions against Moscow over its failure to end fighting in Ukraine.
Stock Markets Spook
News about the Malaysian Airlines passenger jet going down in Ukraine near the Russian border spooked investors, causing stocks to lose altitude and investors to flock to US Treasury bills. In the aftermath of these tensions, gold jumped as traders sought comfort with assets viewed as safe havens in times of turmoil. The flight intensified late further with heightened tension in Gaza between Israel and Hamas escalated as Israeli forces launched a ground offensive, making the markets even more jittery.
The S&P 500 posted its biggest one-day percentage decline since April 10, 2014. Meanwhile, the Chicago Board Options Exchange’s VIX Index, often referred to as Wall Street’s “fear gauge,” spiked more than 32.18% to 14.54, its biggest one-day rise since April 15, 2013.
The Dow Jones Industrial Average fell 161.39 points, or 0.94%, to 16,976.81, the S&P 500 lost 23.45 points, or 1.18%, to close at 1,958.12, and the Nasdaq Composite dropped 62.52 points, or 1.41%, to 4,363.45.
The benchmark US 10-year Treasury note rose 22/32, dropping the yield to 2.4584%, not far from the 2014 low of 2.438%.
Gold prices jumped more than 1% in its biggest one-day advance in about a month. An ounce of the yellow metal was up nearly $17.10, or 1.3%, to $1,316.90.
The Russian rouble fell 1.8%, its biggest drop since August 2011 against the US dollar, having already lost ground because of the heightened American sanctions. Major European stock indexes fell just before the close of trading.
Impact on Financial Markets
It is not unusual for investors to run for cover when unexpected events with so many unanswered questions and potential consequences occur. These are volatile parts of the world, as Ukraine and Russia have been sparring in the area for months, and the Middle East tensions have been escalating for more than a week.
Geopolitical risks often spook the financial markets, especially in the short term, as investors wait to gather more information and find out exactly what happened. And news like the plane crash in a part of the world that has been volatile is an event that gets Wall Street’s attention.
Strategists also note that past geopolitical flash points have tended to have little lasting impact on financial markets beyond an initial knee-jerk reaction. Oil, for example, spiked earlier this year as the Ukraine crisis initially flared and Russia annexed the Ukrainian region of Crimea.
Attacks by Sunni insurgents in northern Iraq briefly unsettled markets and sent oil to nine-month highs in June, but soon lost their impact as investors felt reassured that Iraq’s oil exports remained insulated from the ongoing violence.
Nils Bohr famous Nobel laureate once stated that “prediction is very difficult, especially if it’s about the future”. While Bohr was widely recognised for his deep understanding of Physics, his quote could just as easily apply to financial markets. Geopolitical events are impossible to predict and therefore little action can be taken in portfolios to combat short-term crises. Ultimately, this would be a form of market timing and we do not believe that anyone can time the market on a consistent basis.
Second-guessing Geopolitics Usually Unprofitable
Equity investors often abandon their long-term plans when geopolitical tensions create market-moving headlines. The morning of a crisis may find the markets recover much quicker than expected.
If a geopolitical crisis does not alter the fundamental argument for an asset, it may in retrospect even be a catalyst to buy, not sell. Investors may initially assume that the markets will take a while to recover and stay on the sidelines. Later, they may find out the recovery period was actually shorter and, in hindsight, an opportunity to gain from the cheaper valuations of stocks. Even when assets bounce back, investors may lack the stomach to re-enter a market that recently saw dramatic volatility. When framed in this context, investors should see geopolitical volatility as an insufficient reason to change strategic plans.
The bottom line about the Ukraine and the US markets, at least from information currently available, is that any future sell-offs could be steep, but would likely be short-lived.