Conflict and Portfolio

An overwhelming majority of retail investors tend to agree that the world's conflicts are unpalatable and detrimental to their portfolio of stocks, that's according to 86 percent of people polled recently. So they would almost all be nodding in agreement that the world's biggest skirmishes, for example the Ukrainian situation reaching boiling point with NATO warning of a Russian invasion, Iraq's ongoing civil war threatening to split the country in two, the Syrian civil war, the ongoing Palestinian Israeli conflict and the ongoing war on terrorism is about to wreak mayhem on their share portfolios.

Perhaps that's a fairly predictable poll result and a normal reaction to the effects of war on a portfolio, after all war is terrible and tragic.

However, with respect to having a detrimental impact on your investments, surprisingly this is not how some legendary professional investors view it. Baron de Rothschild once famously, or callously said depending on how you view it, "The time to buy is when there is blood in the streets."

Apparently, if we look back in history to a number of previous conflicts and its impact on stocks we can deduce that despite war being an awful prospect it didn't actually knock stocks off their bullish trajectory. There are a number of reasons why this might be so. The current conflicts seem to be relatively short in duration and confined to small areas of the world to have any significant impact on the global economy and corporate earnings. Obliviously, there are exceptions to this, particularly when the localised conflict involves a strategic region, for example fighting in the Persian gulf could have an impaction on the supply of oil and its price. Skirmishes in the world's most important shipping routes, such as the Panama canal might cause frightened ships to divert their passage to safer but longer routes, this would increase transportation costs. Conflicts in areas containing logistically important gas or oil pipelines supplying other major regions, such as the Ukraine could also result in cuts or disruptions to supplies, which would raise energy costs in Europe.

So with the exception of fighting breaking out in “logistic" or strategic regions of the globe, it would usually take a massive global war to send stocks crashing. Modern market history suggests that even recent skirmishes involving major powers like America and Britain – have not had a significant global economic impact. While the current conflicts raging today are disastrous for those unfortunately involved they are probably unlikely to have any real significant impact on the global economy and corporate earnings.

Take for example the Korean war. The S&P 500, a compressive index with the longest historical data available, initially stocks experienced a rapid sell off, falling by 14% between 12 June 1950, just 14 days before the war began, and 17 July 1950. But just two months later stocks had recovered their losses and were back in the black. Over the entire conflict, from 25 June 1950 through 27 July 1953, the S&P entered a strong secular bull market rising over 25 percent during this period.

Even at the height of the cold war period during 1962's Cuban Missile crisis with Khrushchev's decision to put missiles in Cuba, which brought America just a footstep away from a nuclear war with Russia, didn't have a significant impact on stocks. However, the S&P 500 followed a predictable trend of falling initially on the outbreak of the news that the Americans discovered Soviet missiles on the Caribbean Island off the cost of Mexico. Stocks hit support levels, a market bottom, on 23 October, 1962 one day after President Kennedy announced the naval blockade. Markets rose the next day, when Soviet Premier Nikita Khrushchev called the blockade an "act of aggression" and told his ships to ignore the blockade and push on. During this tense period the stock market held firm, there were no sharp sell-offs while the Soviets tested American grit to enforce the blockade. When the Soviet ships turned around on 5 November, that year the S&P rallied up 9% off the October lows low and a secular bull market ran strong from there onwards for more than three years.

With respect to the Middle East, stocks fell in the run-up to the Six Day War among Israel, Syria and Jordan, during June 5 1964 and June 10, but the S&P 500 rose during every trading session once war began.

Most recently in the middle east with the Iraq war Markets fell before both official Iraq Wars - 1991 and 2003 - but soon reversed and finished strongly positive both years. Global markets rose 22.1% in 1991 and 19.7% in 2003 (both in Sterling).

What about the recent war in Europe in the mid-1990s; the Bosnian War? The trend is to repeat yet again. Stock Markets were volatile in 1994 as conflict started to boil, but world stocks bottomed in late January 1995, shortly after NATO air strikes began in Croatia. Stocks gained even as fighting lasted through 1995, despite the past atrocities like the Srebrenica Massacre. From the 24 January low market point through year-end, world stocks gained 23.7%.

So there's enough evidence from history to support the view that on the eve of war the stock markets trends experience a selloff and fall, perhaps this is due to investors overreacting to the event. Then for some reason afterwards, on the sounds of gunfire, the market bottoms out and enters a new cyclical bull cycle, running for three plus years.

There's only one event in history that breaks this trend; Hitler’s invasion of Poland that triggered off WWII, markets remained depressed for years.

Unless you believe we are on the eve of WWIII, which is hopefully unlikely, then the Ukrainian crisis might represent buying opportunities for investors.

A New Bank for the BRICS

As five leaders, representing nearly half of the world’s population, descended on the Brazilian city of Fortaleza to attend the sixth BRIC’s (Brazil, Russia, India, China and South Africa) Summit, scheduled for July 15-16, elaborate security measures were being put in place, street drains within proximity were meticulously inspected, local police had cordoned off the area to traffic and military jets prowled above the skies ensuring that the no fly zone within proximity of the Summit’s venue were observed. But it wasn’t the security activities around Fortaleza (Fortress) that grabbed the headline, but rather what was being discussed inside the Summit. 

As the leaders sat around a table, they were discussing the potential end of, what they perceived to be, the way mega business, aided and abetted by the US and its allies, had an unchallenged ability to exert a wielding influence over the world’s economy since the end of WWII. The International Monetary Fund (IMF) and the World Bank, both institutions established almost 60 years ago by the world’s most powerful nations in the aftermath of WWII, is increasingly being viewed by the group of BRICS nations as pretty much the facilitators for US and allied economic supremacy. While the World Banks and the IMF, both share the same aim of ending extreme poverty and boosting shared prosperity this seems less realistic today with rising inequality, even among developed nations. Moreover, these altruistic goals are perhaps a smokescreen for their true function, according to critics who believe that these financial institutions are merely tools of corporatocracy, a society or system governed by corporations. “When the IMF or World Bank lends money, strings are invariably attached, and those strings tend to reflect the values and interests of Washington and its allies,” said an analyst at the Institute for Development Studies in Sussex, UK.

So the BRICS plan, to resist a society ruled by big business and White House policies, is to launch its own development bank, called the BRICS bank and a monetary stabilization fund called the Contingent Reserve Arrangement (CRA). Indeed, adding flesh to the bones, BRICS nations were able to conclude at the Summit in Fortaleza the financing structure of the BRICS bank and CRA. Both BRICS financial institutions will rival the World Bank and the IMF and are scheduled to be launched at the conclusion of the Summit. The choice of city is expected to be made soon along with the leadership of the bank, which will be rotated every five years.

The CRA will have 100 billion, with China being the largest contributor of 41 billion USD; Brazil, India and Russia, with all contribute 18 billion USD each and South Africa will add 5 billion USD to the fund. The BRICS Development Bank will begin operation with a capital of 50 billion dollars with contributions of 10 billion and guarantees of 40 billion from each of its members. The BRICS Bank has ambitious expansionary plans. It intends to expand 100 billion dollars within two years, and up to 200 billion in five years. The Development Banks projected capacity for financing projects is anticipated to total 350 billion USD by 2019. This is certainly by no means small beer. 

Therefore, assuming the BRICS Development Bank and CRA are successful, it would be reasonable to assume that these newly formed financial institutions could then end the monopoly stranglehold that the IMF and the World Bank’s has over financing large scale international development projects. Additionally, for the economies involved in the architecture of BRICs financial institution, being able to circumvent the World Bank and the IMF for development aid and apply to their own group’s BRICS Development Bank may be a real boon. The BRICS economies might be able to benefit from the no strings attached financing of the group of countries new BRICS Development Bank. Previously, much World Bank development aid concerning hefty infrastructure projects in developing countries tended to be tied down to the approval of finance, which was subject to contracts being awarded to US and western corporations. Moreover, interest payments on the loans made also resulted in payment outflows from the BRICS economies. In view of this, it then becomes fairly apparent that the creation of BRICS Development Bank, in theory is likely to be a boost to BRICS companies, their bank and its economies. 

On the other hand, the implications for US and allied corporate titans may not be so favourable in so much as it could also extinguish an era of plum public contracts being awarded on a silver plate to these corporations. There might also be the added risk that the BRICS Development Bank could deliberately or by chance promote policies within BRICS nations and beyond that are at odds with those of the White House. So it’s reasonable to assume that the BRICS bank could act as a facilitator in the shifting of economic and political power from the West to the East.

However, the extent to which this power and political shift plays out depends on the BRICS Development Bank’s effectiveness as a means of financing infrastructure projects within the group’s countries and beyond. If the BRICS bank is just another replica based on the IMF and World Bank model, with its criticized shortcomings, then its influence may not be as significant as anticipated by its architects. Like any institution, it is run by human beings who often have self-serving interests, combine this with little transparency and practically no press freedom in a number of BRICS countries and it might just be the perfect cocktail for a few oligarchs becoming even more powerful at the cost of many. That would be worse than corporatocracy.

But that’s maybe just a cynical view, on the upside the BRICS Development Bank has maybe got the world’s financial architects thinking about the need for change. If that is the case, then let’s hope that what emerges is for the greater good.