Global risks wobble markets

Recent tensions between NATO countries and Russia over Ukraine have fueled the latest spell of market weakness and volatility. Geopolitical risks are impossible to model accurately, and therefore often lead to emotional swings in global equity values. A Gallup survey showed that 75% of investors worry about geopolitical risk.

Economists Dario Caldara and Matteo Iacoviello of the Federal Reserve Board of Governors constructed a new measure of adverse geopolitical events based on a tally of newspaper articles covering geopolitical tensions and examined its evolution and economic effects since 1900. The geopolitical risk (GPR) index spiked around the two world wars, at the beginning of the Korean War, during the Cuban Missile Crisis, and after 9/11. The most recent reading was 109 in January, but it is almost certain to surge in February due to the intense focus on Russia, Ukraine, and to a lesser extent, China and Iran.

Since 2004, there have been seven events that caused spikes in the index above 130 as indicated in the chart above. These spikes were relatively minor with 9/11 showing a spike to 513 and the 1991 Gulf War up to 379. Each of these events caused market disruption and volatility with the S&P 500® Index roughly flat over the subsequent six months. In all but one instance (Russia’s annexation of the Crimea in 2014), the S&P 500 was higher in the 12 months following the spike by an average of 8%. Investors should remain vigilant and informed in the face of uncertainty, though reactive and emotional actions are rarely an advisable investment strategy.