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Why the markets brush off horrific world events

Investors pay more attention to QE than to today’s skirmishes.

  • By Matthew Lynn,
  • MarketWatch
  • – 07/23/2014
  • Emerging Markets
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A plane carrying close on 300 innocent people gets shot down along one of the most sensitive borders in the world. Israel invades Gaza, reigniting the deepest wounds in the Middle East, and potentially sparking another regional conflict. A few hundred miles away, a militant insurgency threatens to turn Iraq into a full-blown terrorist state.

The world has not been short of things to worry about in the last week, or the news bulletins short on drama and conflict.

More on markets

Helped by easy money and low inflation, market volatility fell and most asset prices rose in Q2 2014. Here's what this may mean going forward.

But how did the financial markets react? A few stocks got marked down, and gold made one of its reflex moves upwards. Yet on the whole, they barely registered any reaction. It was as if nothing of significance had happened.

There is a message in that, and an interesting one.

The markets are no longer interested in what happens in the rest of the world. The days when geopolitics could impact the prices of stocks, bonds, commodities or currencies in any significant way have been consigned to the past.

There are two possible explanations for that: firstly that there are not any wars or revolutions any more that can dramatically change the outlook for the global economy; and secondly, that the markets are so pumped up by quantitative easing, and easy money from the central banks, that anything else that happens pales into triviality by comparison.

The truth is probably somewhere in between. Either way, investors can safely ignore war and politics from now on when they are structuring their portfolio.

The declining interest of the financial markets in what is happening around the world has been evident for some time. The Arab Spring that saw governments fall across the Middle East was probably the last set of uprisings to make any real impact, but even that was largely restricted to frontier indexes such as Egypt, and they don’t count for a great deal in the greater scheme of things.

But it has been most noticeable this year. It is not as if the past few months have been short on drama. The Russian annexation of Crimea, and possible capture of eastern Ukraine, marks the first major re-drawing of national orders within Europe in many years. It could easily turn into the beginning of a new period of conflict between Russia and Western Europe — the opening salvos of a new Cold War.

Likewise the militant uprising in Iraq could easily result in the creation of a terrorist Islamic state in a country with some of the largest oil reserves in the world, and which only 10 years ago the U.S. considered so strategically important it invaded to bring down what it regarded as a rogue regime.

Tension between the Israelis and the Palestinians is hardly anything new: the invasion of Gaza is merely the latest in a long and bitter history of conflict. Even so, it remains one of the most disputed regions in the world, and one where any military action threatens a wider conflagration.

Not so long ago, geopolitical events such as those would have provoked wild swings in the financial markets. After the 9/11 attacks on Washington and New York, the stock market fell dramatically. The Iraqi invasion of Kuwait sparked a wave of selling, and the Middle Eastern conflicts of the 1970s sent the oil price soaring and the stock market crashing.

Now, events such as we have seen over the past week are regarded with supreme indifference. Financial journalism is as conservative a trade as any other profession, so there were plenty of headlines about the stock markets crashing on the downing of the Malaysian airlines jet.

If you looked closely, however, the interesting point was not how much the market moved but how little. The Dow (.DJI), in line with other bourses, lost 1% or so on the news, and quickly recovered those losses the next day. It was typical of the kind of modest moves seen most weeks. True, the Moscow index faced heavier selling, started by fiercer U.S. sanctions, but it was still only down in the 4% to 5% range over the course of a couple of days.

The reality is, there was barely any reaction to speak of. The headlines were just a reflex.

There are two explanations for that.

The first is that in the post-Cold War world, none of these local regional conflicts really count for much. Nothing that happens in the Ukraine has any significant impact on global trade. Its economy is so small, it is not really a player. If it collapses into chaos and civil war, the multinationals will not be making any less money than they were before.

Much the same is true of Iraq. It is not a major market for anyone.

Even the wider Middle East is losing its power to influence the global economy. Oil is its only product that matters. But with the development of shale gas, and the plummeting price of solar power, oil is far less important than it used to be. If war erupts, it needn’t hit living standards in the developed world.

The second reason is that the markets have become decoupled from the real world. Over the last five years, they have been driven by the central banks. Decisions over interest rates, and whether to keep printing money or not, matter far more than any regional war. So long as the Fed or the European Central Bank keeps liquidity cheap, they will keep rising, regardless of what happens elsewhere.

Armies of analysts, and fund managers at the big macro funds, make a living from analyzing geopolitical trends, and moving their money around accordingly.

Increasingly, however, it looks like a waste of time.

Nothing that happens in the outside world matters to the markets right now. A war between China and Japan might change that. So could the collapse of the European Union and the single currency.

But unless it is something that big — and those two examples both seem very unlikely — investors can stop worrying about the headlines from around the world. None of them are going to impact your portfolio.

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