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How war affects stock markets

With diplomacy failing and the risk of the US going to war with North Korea increasing with each passing week, you would have to think that the stellar US sharemarket Bull Run will come to an end.  Or will it?  Contrary to this seemingly common sense, share markets tend to rally whenever the US begins military operations overseas.  Why?

One word: certainty.

Quite simply, a call to arms essentially puts an end to the speculation of whether it will happen or not, and we all know markets detest uincertainty.  The two graphs below illustrate the historical short term market reaction to formal declaration of wars and geopolitical events, followed by an appreciation in the following 6-12 months.

In fact, most geopolitical crises over the past 100 years have had almost no impact at all on major stock markets.  An analysis conducted by Ned Davis Research of the most momentous geopolitical; crises over that time found that rather than fall, the Dow Jones actually strongly rebounds from its associated “panicked” low. Tellingly, what mattered most was the overall direction of the market, not the outcome of the crisis.

When it comes specifically to North Korea, historically, stock markets have always reacted negatively to their penchant for launching missiles, but ultimately, these pullbacks are very short lived.  Generally the reaction for investors is to sell stock, rush to safe havens, assess the situation and then buy back in.  Selling into a panic is never the solution – in fact, Geoff Wilson of Wilson Asset Management sums it up well when he says “work against your emotions and take a long term view when investing”.

It is fair to ask that with the Dow Jones having broken above 23,000 for the first time last  week (16% higher than where it sat 12 months ago pre Trump),  is it time for a correction anyway?  AMP chief economist Shane Oliver agrees that “the intensification of the risks around North Korea comes at a time when there is already a risk of a global share market correction”.  However, short of a significant and lengthy conflict, Mr Oliver would view any pullback as merely a correction rather than the beginning of a bear market.

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