Geopolitical tensions and periods of war not only influence society’s peace and security but also affect global economies and stock markets. Throughout history, moments of international conflict or heightened geopolitical risk have triggered stock market reactions and increased volatility. Currently the world is dealing with several instances of conflict and risk including Israel/Hamas/Iran, Russia/Ukraine, and China/Taiwan.

Following Iran's attack on Israel and Israel's counterattack, US stock markets declined due to concerns about potential escalation and the spread of conflict to other regions. In times of uncertainty, it is helpful to examine historical patterns to gain insights into how stock markets may respond to geopolitical escalations.

• History suggests that markets react quickly to news of geopolitical unrest and escalation.
• Stocks tend to rebound quickly, and often before any actual resolution to these events.

This pattern suggests that while initial reactions can be negative, markets may adjust as the situation evolves and investors gain more clarity.

As shown in the table above,[1] the average one-day market reaction to historical geopolitical escalations and war outbreaks is a decline of 1.1%, and the average total decline is about 4.7%. The time the market needs to recover from losses fully is about 42 days on average. The market reaction to the outbreak of the war between Israel and Hamas on Oct. 7, 2023, was less intense than the long-term average, with a one-day positive reaction of 0.3%, a total drawdown of 4.5% and a recovery time of 19 days until the stock market was back to its former level. In contrast, the impact of the escalation between Russia and Ukraine in February 2022 led to a one-day decline of 2.1%, a total drawdown of 6.8% and the recovery of incurred losses needed 23 days.[2]

It is worth noting that each geopolitical concern has multiple factors that are in play, and reactions often depend on current economic conditions and how the economy could be affected by these specific events.

Depending on where these events occur, the energy sector often experiences the first effects during geopolitical unrest. Escalations can contribute to oil production and transportation issues, which leads to increased price volatility. Tensions and war can also lead to disruptions in global supply chains, impacting companies and their ability to trade goods and get supplied with essential materials for production. All this can lead to higher prices of energy and goods (inflation) which could ultimately affect both business health and consumer pocketbooks.[3]

There is no question that geopolitical unrest and wars are inherently destructive and devastating to the people directly affected. While these events can also increase stock market volatility in the short term, the longer-term effect is dependent on their impacts on economic growth and business health. Using history as a guide, geopolitical escalations without significant changes to economic trends often have a short-lived and relatively muted impact on the US stock market.

At Gradient Investments, we will monitor the geopolitical situation in the Middle East and other regions to assess risk and make adjustments as needed. If we believe escalation of these events is going to have severe consequences that require greater adjustment, we will communicate our thoughts accordingly.

[1],2 LPL Financial, Middle East Conflict: How Stocks React to Geopolitical Shocks.

3   Economics Observatory, How are geopolitical risks affecting the world economy?