Certainly early signs would suggest this is happening: Equity markets have remained flat in the face of some strong economic data with many analysts blaming the possible military intervention in Syria for creating market uncertainty. Emerging markets have been a particular target, with emerging market equity funds seeing net outflows of $3.9bn in the last week of August.
That said, 10-year government bond yields have continued to grind higher, so there appears to be no immediate re-embracing of expensive fixed interest. But at a time when many investors are reconsidering their fixed income exposure, the increasing attraction of more defensive assets provides a new reason to hold.
Previous conflicts
An analysis of market behaviour during previous conflicts perhaps provides some clues as to the likely impact of the latest conflict. The economist David Smith, writing in 2003, analysed the trajectory of stock markets during the two Gulf wars. He found that stock market fell by around 20% following Iraq’s invasion of Kuwait in July 1990. They began to recover with the combined military action against Saddam’s forces in January 1991 and by the time of the ceasefire were 10% above their initial level.
During the second Gulf war, a similar pattern was seen with markets lurching down in the run up to war. However, markets started to recover before military action was taken and the recovery continued during and after the conflict. If markets follow a similar pattern this time, they would be due to rise higher when Western governments decide on their strategy.
However, this is short term and sentiment driven. Could there be a longer-term economic impact from military intervention? Here, the worry is the likely impact on the oil price. There has been a spike in oil prices since the start of problems in Syria, as there often is from unrest in the Middle East. This raises the prospect of a rise in inflation, which could – in turn – knock the nascent economic recovery.
Keith Wade, chief economist at Schroders, has argued convincingly that Syria is not critical to global energy supplies and the spike in oil prices, therefore, is unlikely to last. He points out that US gasoline prices are still within their recent trading and lower than a year ago. However, should the oil price spike higher than $125 a barrel, there is a risk that it will have an impact on global economic activity.
Spook the Fed?
There is the possibility that intervention in Syria will encourage the Federal Reserve to defer the end of quantitative easing. As equity markets are still troubled by the de facto monetary tightening prompted by the sell-off in the bond markets, this is potentially a positive outcome from the unrest.
It is worth highlighting one final piece of research by economics professors David Cutler of Harvard, James Poterba of MIT, and Larry Summers, which suggests that ‘non-economic’ news actually has little long-term impact on stock markets. Their research looked at 49 world events, beginning with Pearl Harbour and ending with the market crash of 1987 and found that the S&P 500 moved a little less than one percentage point more than it did on all other days.
Ultimately, equity markets are a discounting tool. Syria has been bubbling away for some time and any ultimate declaration of war should not prompt a market shock. If economic data continues to be robust, it is unlikely to push investors back to still expensive defensive areas in the long term.