Profits Continue Strong Despite Geopolitical Tensions
After a very calm market environment in the months of June and July, we are recently seeing some turbulence with a rise in geopolitical tensions between the U.S. and North Korea. The nuclear threat from North Korea and the stern response from the U.S. have caused anxiety among investors, and as a result, the Chicago Board Options Exchange (CBOE) Volatility Index, or the VIX, has spiked more than 50% from its July lows.
VIX Index Spikes Due to North Korea Threat
Source: Bloomberg, as of 8/10/17. Past performance is no guarantee of future results, which will vary. It is not possible to invest directly in an index.
However, history tells us that geopolitical events rarely have an enduring impact on the markets. We have seen many instances in the past where heightened geopolitical tensions unsettled the markets in the short term, but in most cases, beyond the initial shock, markets held up well through the subsequent period of geopolitical uncertainty. For example, during the Cuban Missile Crisis in October 1962, the S&P 500 Index fell close to 4% immediately, but recovered within a week.
We also saw similar patterns during the Third Taiwan Strait Crisis in 1996 and during the artillery engagement between North and South Korea during November 2010.1 We believe the parties involved understand the catastrophic consequences of a nuclear conflict, and this will most likely restrict the current engagement. Historically, very often, geopolitical tensions turned out to have little impact on the trends of the economy and corporate profits, which – at the end of the day – were key drivers of equity returns.
S&P 500 Index 2Q 2017 Earnings Surprise
Source: Bloomberg, as of 8/9/17. Past performance is no guarantee of future results, which will vary. It is not possible to invest directly in an index.
Corporate profits continue to be strong. So far this quarter, the S&P 500 has seen an earnings growth of almost 10%, and 10 out of the 11 Global Industry Classification Standard (GICS) sectors have beaten their estimates. In addition, the forward-looking expectations from analysts point towards an earnings growth of 10% – 11% over the next 12 months. Overall, we believe the backdrop remains quite supportive of risk assets.
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1. Bloomberg, as of 8/10/17.
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The Standard & Poor’s 500 Index (S&P 500) is an index of 500 stocks seen as a leading indicator of U.S. equities and a reflection of the performance of the large-cap universe.
The CBOE Volatility Index (VIX Index) is a key measure of market expectations of near-term volatility conveyed by S&P 500 stock index option prices.
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