Iran Tensions and Geopolitical Shocks: How Stocks Usually Respond

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Things usually aren't as bad as they seem - at least for stocks when it comes to military conflict and war.

The U.S.-Iran tensions have spurred some volatility in U.S. stocks in the past several days.

Investors, fearful of a massive war, have taken to risk-off sentiment. In the past five days, the S&P 500 has swung from 3,248 to a low of 3,214 and then up to 3,258 Wednesday.

Stocks got a boost Wednesday when President Donald Trump indicated Iran appeared to stand down on the conflict.

But investors still have moved somewhat into safety, with gold touching a seven-year high of $1,316 on Tuesday and the 10-year Treasury yield (which drops as the bond price rises) falling to 1.87% from 1.92% five days ago.

This came after Iran on Tuesday shot missiles at Iraqi military bases used by the U.S. and Iraq, in retaliation for the U.S.'s killing of the Islamic Republic's top general.

It isn't safe to say the conflict with Iran is over. But maybe a review of how stock investors usually behave around conflict periods would give some useful perspective.

"No doubt worries over Iran have investors on edge," wrote LPL Financial's senior market strategist, Ryan Detrick, in a note. But "the impact to stocks from geopolitical events historically has tended to be short-lived."

According to data compiled by LPL Financial, CFRA Research and S&P Dow Jones Indices, on average the S&P 500 falls 5% after a major geopolitical event and then makes a full recovery within 50 days. The figures reflect events dating back to 1941.

On average, it takes only 22 days for the index to hit its bottom within that 50 day period. It takes an average 47 days for stocks to recover from their previous level.

The worst drop in the S&P 500 after a major geopolitical shock was 19%, after the Pearl Harbor attack.

LPL's data measure 20 events, including the Cuban Missile crisis of 1962, the terror attacks of 2001 and the North Korea missile crisis of 2017.

According to LPL, the Dow Jones Industrial Average since 1990 has risen 88% of the time in an average three to six months after a geopolitical crisis. That study includes events such as the Iraq War and the Gulf War. The average three-month and six-month gains after the crisis are 5% and 7.9%, respectively.

Maybe these positive trends aren't so surprising. Many geopolitical crises, scares or spats don't lead to wars, and stocks historically usually rise in a one-year period.

But for 2020, stocks are seen to have limited upside, as the U.S. economy - trending as well as it has in recent months - is generally believed to be late in its current cycle.

Canaccord Genuity's chief market strategist, Tony Dwyer, wrote in a note Tuesday that valuations are too high, with the average forward one-year earnings multiple on the S&P 500 at 19. He says the market is due for a correction.

The U.S. market has "become increasingly overbought," strategists at Hercules Investments wrote in emailed remarks to reporters.