The devastating loss of life resulting from Hamas’s surprise attack on Israel is at the forefront of our concerns. Risk of a prolonged conflict in the region has grown, creating a new layer of uncertainty on many fronts, including the global economy and markets. The global economic impact is likely to remain subdued absent Iran becoming directly involved in the war, which would have material and uncertain consequences. Thus far, market reaction has reflected these circumstances, with global equity prices appreciating, oil prices up just 1%, and the US ten-year Treasury yield down 20 basis points to 4.58% through October 11. We would not de-risk portfolios, given the uncertain nature of how this will evolve and that market downturns driven solely by geopolitical events have tended to be short-lived. Rather, we would rely on existing sources of diversification within portfolios and consider stress testing portfolios to ensure there are adequate sources of funds to meet potential liquidity needs.

Historically, major geopolitical events have seen equities experience sharp, short-lived sell-offs followed by rapid recoveries. On average, global equities have declined by about 8% in the immediate aftermath of these events, with recoveries beginning less than a month after the sell-off started. The worst returns occurred during more severe events, such as the Korean War, or events that coincided with recessions, such as the Arab-Israeli War/oil embargo of 1973 and the September 11, 2001 attacks. To be sure, geopolitics can aggravate the economic environment. Ultimately, much depends on the scale and duration of the conflict.

The markets’ timid response to current conditions reflects the limited economic implications globally at present. Thus far, there has been no confirmation of Iran’s direct involvement in the planning of the attacks, and the risks of expanding the war into Iran should serve as a meaningful deterrent to Israel absent clear and convincing evidence. Further, positioning for an increase in oil prices may be short-sighted, as meaningfully higher oil prices could also dampen oil demand. The bigger impact could be the economic and financial strain that providing further military support would place on the United States and Europe.

Positioning portfolios for specific geopolitical events can be hazardous as they add uncertainty to investment outcomes, the magnitude of the sell-offs varies, turnarounds tend to start quickly, and other factors (such as economic conditions, market fundamentals, and valuations) often dominate over longer horizons. Diversification across geographies and strategies with different economic basis of return and careful liquidity management are the best portfolio defense.

Celia Dallas, Chief Investment Strategist

Sean Duffin, Senior Investment Director, Capital Markets Research