Geopolitical Shocks and Financial Markets

Acting-Man

Involuntary Early Retirement of a Middle Eastern General

The procession of news through the week – namely that chronicling the aftermath of the targeted drone strike and killing of Iranian General Qasem Soleimani – advanced with an agreeable flow.  The reports at the start of the week were that Orange Man Bad had spun up a Middle Eastern mob of whirling dervishes beyond recall. World War III was imminent.

The recently expired general, when he was still among the quick – and seemingly in a good mood.  [PT]

Photo via harpy.ir

But after Iran’s token missile launch on Tuesday, with no American causalities, President Trump Tweeted: “All is well!”  Then, on Wednesday, major U.S. stock indices gave the “all clear” signal.  By Thursday, the Dow Jones Industrial Average (DJIA), the S&P 500, and the NASDAQ were all marching to record highs. The DJIA even came within a horse’s hair from taking out 29,000.

What’s more, the price of crude oil fell below where it was before Soleimani was killed.  No harm, no foul.  What to make of it?

According to traders, everything is awesome.  Still, we have some reservations.  Our best guess is that this week’s agreeable flow of news will be followed by a disagreeable ebb.  Conceivably, it marks the first paragraph of a new chapter in America’s forever war in the Middle East.

The stock market barely flinched (Qasem who?) and crude oil quickly gave back its gains again. Evidently, upheaval in the Middle East isn’t what it used to be. [PT]

In the interim, however, we will consider the events of the last 10 days an experiment.  Here, with little consequence (at least for now), we have been gifted a sampling of how financial markets behave when a burgeoning geopolitical crisis hits.

We posit that during the initial fog of a geopolitical crisis financial markets don’t have the faintest inkling of potential risk.

Hyperventilating Minds

Financial risk, for our purposes today, is not a quantified statistical measurement.  We are not concerned with the risk differential between high beta and low beta stocks.  Rather, at the commencement of a major conflict, risk is specific to the probability that a foundational change results which wipes away capital permanently.

Author Fred Sheehan wrote a piece titled, “War of the Nerds,” for the December, 2006, edition of Marc Faber’s Gloom, Boom & Doom Report.  Several years ago the article was still posted at Sheehan’s now defunct Au-Contrarian website.  By chance, before the site vanished, we preserved the following excerpt:

“Every generation suffers its particular fantasies.  So it was a century ago.  Investors had grown so immune to the consequences of war that bond markets from London to Vienna didn’t flinch after the assassination that provoked World War I.

“Three weeks later, in the summer of 1914, the fear premium amounted to a total of one basis point. Then, in quick order, European markets ceased to function. A notable feature of this paralysis is that nothing of substance had changed – war had not been declared by any …read more

Source:: Acting Man