Should the markets fear conflict in Syria?

            

                 As the US and other nations size up whether they are going to bomb Syria, potentially risking a wider regional war, equity markets took fright last Tuesday and recorded a 1-2% drop across Europe and the US as this prospect looked an inevitability. Oil began rising quickly over the fear any conflict could affect supplies whilst some investors began going long on Gold, the traditional safe haven, pushing the price up. Whilst the immediacy of any action has reduced slightly over the last couple of days, leaving markets to concentrate on the economic recovery and Fed tapering, the likelihood is still there that some form of action will soon be upon us. The market slide on Tuesday got me thinking as to whether investors really weigh up the implications or they just automatically sell at the fear of war.

                          As with all events, investors want to make sure they are betting on the right side. In 1815 Nathan Rothschild posted his own messengers on the battlefield of Waterloo in order that he could know as soon as possible who the victors were. In fact his messengers arrived back to London a full day before the official British messengers enabling him to take advantage in the markets (although the extent to which he profited from this event versus the losses he occurred on other long term bets is disputed). Nowadays traders get real time information (and misinformation) direct from their Bloomberg terminals and 24 hour news channels with the likelihood for any competitive advantage significantly reduced. But is there really the need for investors to fear action in Syria or is any sell off in advance of military action a pointless gesture when measured in it's real impact on the fundamentals in the market?

                                   In the more recent past, evidence seems to suggest the economic impact on the main western economies of military conflict is relatively minor. The economy appears to plug along regardless of what the military forces of the UK, US or France might be involved in and the initial market fear is usually quickly erased. It is of course difficult to completely isolate the impact made by conflict, and the other consequences of those actions, on the market itself, but it is useful to look at how the market performed during similar military confrontations over the last 25 years. The market reaction to military intervention in general tends to show a similar pattern of showing fear (even if limited) in the lead-up, but by the time the bombing or conflict begins the impact has been weighed up as ineffective on the wider economy and so investors carry on as normal and return to focus on everything else. In the days leading up to NATO bombing in Kosovo, for example, the S&P 500 fell 3.4% but this level was recovered within days. With the Iraq War in 2003 the S&P 500 saw a fall of 9% between the day in October 2002 that the Senate passed a resolution authorising force in Iraq until 11th March 2003, a few days before the start of the conflict. This was entirely reversed however just over a week later by the time the conflict actually started on March 20th. Meanwhile the impact of the start of bombing on Libya in 2011 on the market was virtually no reaction whatsoever. Whilst the S&P 500 was seen to be down as much as 13% during the course of the Libya campaign this was due to the ongoing economic issues from the recession and bore no impact from the consequences of military action.

                    So if the recent past seems to indicate limited impact from the involvement of the US and UK in the end, why then are we seeing market jitters at the hint of action (from the US even if the UK opts out)?

                      As always with the market, it's the fear of the worst from some, and the fear of missing out (FOMO - more technically known as herd behaviour) of others not wanting to get left holding the the wrong assets should things deteriorate, which is causing the additional drag. There is no doubt that there are substantial risks associated by any Western attack on Syria, the main one from an economic point of view being the potential for regional destabalisation, in particular the involvement of Iran. Syria itself has limited impact on oil supplies, but should Iran feel the need to get directly involved (as opposed to using proxies such as Hezbollah) it could potentially disrupt oil supplies in the Straights of Hormuz which in itself would force the price of oil up further. This increase in oil price, especially for a sustained period of time, would put pressure on the economic recovery across the globe and would also directly hurt households with increased petrol and heating costs potentially right as winter approaches. The First Gulf War back in 1991 had a similar impact in it's lead up following Iraq's invasion of Kuwait on 2nd August 1990. Back then spiraling oil prices actually pushed the US back into recession with equity markets also falling up to 16%. The downturn was however shortlived with markets recovering within 8 months of the initial invasion by Iraq once the conflict had started, while the oil fears were reduced by Saudi Arabia providing additional supply within a couple of months of Iraq's initial invasion.

                        The lead-up to the 1991 Gulf War can be seen as an example of where the fear of the worst can itself have drastic consequences, even when the end result from the conflict shows those fears as being overblown. With the markets returning to their levels before the invasion within a relatively short space of time for such a steep decline (16%), investors who would have panicked and sold equities in fear on the downward spiral and only gone back in once the war was over, as I'm sure several did, would have suffered financial losses as a result (in addition to their costs of having to execute the transactions) as opposed to those who held on in anticipation of a swift recovery.

                    The benefit of hindsight is always wonderful in these situations. The world at that time was only just out of the cold war, and had recent memories of the effects of the oil crises of 1973 and 1979 to drive it's fear that the effects of conflict with Iraq may not be as short and successful as it turned out. Saudi Arabia itself after all was seen as a next potential target as well. More recently however interventions in these conflicts have become more regular, with western intervention to various extents in Bosnia, Kosovo, Afghanistan, Iraq and Libya all coming within the last 20 years, and as we've seen with only relatively brief, if any impact on equity markets. The likelihood is here too that any intervention in Syria will remain brief and localised. There are prospects of Iranian involvement, but again this matters only to the markets in as much that it will disrupt factors which effect the economy. For any medium or long term investors in equity it would seem good enough to sit and watch any market volatility in the lead up to conflict, in the knowledge that markets will revert once it becomes apparent there is no real economic impact in the West. The real focus from an investors perspective, should be whether the current levels of growth will gain speed, that too will become more apparent in the coming weeks.