Insights

Is This Time Different?

July 24, 2014

Markets react to geopolitical pressures.

Look at 9/11.

Or the subsequent war between America and Iraq.

Or the Greek Debt Crisis that threatened to bring down the Euro Zone.

But to borrow the name of a seminal macro-economic book, it seems, This Time Is Different.

We are in the midst of not one but two violent conflicts – between Israel and Hamas on one hand, and between Ukraine and the Russian separatists on the other. Worse still, one cannot fathom the implications of a powerful ISIS in Syria and Iraq.

Yet, if a Martian were to track the S&P, Nasdaq or the DJIA over the last 2 weeks, he wouldn’t be able to say that inhabitants of Earth live in geopolitically stressed times.

So what is going on? Have things really changed? Is This Time Really Different?

Well, maybe.

But before we answer that, it might help to step back and understand why markets react sharply to geopolitical events in the first place.

Geopolitical risks, by nature, induce uncertainty. Financial markets hate uncertainty. For example, a crisis in the Middle East always raises questions over consistent production and supply of crude oil. If either is interrupted, investors fear an increase in crude oil prices can escalate costs of production and adversely impact bottom lines for several industries. Markets typically react to such crises by baking in prospects of lower profitability, eventually resulting in falling market prices.

And this brings us to July, 2014.

Are the current conflicts in the Middle East and along the Ukrainian border any less potent than the crises of the past in injecting uncertainty in financial markets? Or have investors become more adept in dealing with such uncertainties?

The answer seems to be the latter.

Historically, investors have been extremely cautious and sensitive to geopolitical pressures. However, this time, unnerved financial markets indicate that the investing community is more sanguine about the outcomes of the two conflicts.

While nothing can compensate for the casualties arising from these conflicts, financial markets have showcased greater appetite for uncertainty this time. As Valentin Marinov, a currencies analyst at Citigroup mentioned, “As [far as] geopolitical risks go, recent history would suggest that we may have to experience a truly cataclysmic event to see a trend reversal lower in the markets. This could mean that the latest developments in Ukraine and Israel may not be such a turning point, however tragic the loss of life has been.” 

So while the inherent nature of geopolitical conflicts may not have changed, the threshold of uncertainty that adversely affects financial markets has changed.

With greater and faster flow of information, investors can take a more granular approach while responding to such crises. As reported by CNN, take the case of two Israeli companies, Nice Systems (NICE) and SodaStream (SODA): while the stock price of Nice Systems remains unaffected, shares of SodaStream have declined by 12% since the beginning of July.

Why?

SodaStream’s headquarters are located near the Ben Gurion airport in Tel Aviv which has been targeted by rockets from Gaza (read: more uncertainty). On the other hand, Nice Systems derives more than 50% of its revenue from sales in the United States and its future prospects are less affected by the ongoing conflict.

Coupled with this granularity, past geopolitical precedents give investors a better understanding of where the aforementioned threshold lies. Currently, the TA-25 index of large Israeli companies is up 1% since the beginning of July, clearly indicating that markets believe the Israeli economy will come out of the conflict relatively unscathed.

So perhaps, this time is indeed different – markets have become more prudent and are avoiding any knee-jerk reactions in responding to geopolitical crises. Now if only our world leaders exhibited the same prudence in avoiding these conflicts in the first place!

Kunal Lunawat is a MBA Summer Associate at Artivest. He is currently studying at Harvard Business School and you can find him on Twitter at @KunalLunawat

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