Our main priority is to hope that war does not break out. Above anything economically or politically driven, the loss of life on both sides could be bigger than anything that has been seen since the Second World War. South Korea is against military action and it is difficult to imagine the US acting against their wishes. A military solution is possible but the consequences are unacceptable to all sides. With most trade and oil supplies into North Korea controlled by China, it is they who can be the most effective in dealing with Pyongyang. The recent test of an H-bomb appears to have raised concerns in China.
Whilst each has notable differences to the Korean situation in their own right, I have chosen three events to look at for the purposes of answering the question at hand: The Second World War, The Cuban Missile Crisis and the first Gulf ar. All of these had the possibility of a global impact on financial markets.
Between 1937 and 1939, as tensions with Germany rose, markets fell over 40% before the outbreak of war. Following the invasion of Poland and declaration of war, with no action on the ground, markets began to recover a little. The so called “phoney war” ended in May 1940 with the German invasion of France, followed by the evacuation of Dunkirk and the French capitulation, all of which subsequently caused a steep sell off in the UK stock market. However, this marked the low point of the war years for stock markets and they began to recover the losses as the Battle of Britain commenced. In 1946, the FT 30 Share Index made a new high.
The event that brought the world closest to nuclear war was the October 1962 Cuban missile crisis. In the September Russia put ballistic missiles on Cuba, directly threatening the US mainland. By October, American spy planes spotted them and between the 14th and 28th of October it looked as if Armageddon was about to happen. Threats were made and nuclear war was a very real possibility, only ending when the Russians agreed to withdraw the missiles. Charts of the S&P 500 equity index in 1962 show a dip followed by a recovery after the crisis was over but a detailed look shows that the fall was mostly in the first half of the year. This was during a period known as the ‘Kennedy Slide’, when Wall Street took a dim view of the newly elected Democrat president and the index fell over 25%. With that in mind, the direct impact of the missile crisis on markets needs to be split out. During the period of the actual missile crisis the US market fell a little over 6% at its worst, so a relatively small reaction. It was making new highs by September the following year.
The Iraq invasion of Kuwait in 1991 came as a surprise and was met with condemnation from around the world. While there was little chance of worldwide conflict, the equity markets sold off sharply as oil supplies came under threat. ‘Operation Desert Storm’ brought the recapture of Kuwait and went some way into Iraq but Iraq gave way and the full removal of the Iraqi regime had to wait for the second Gulf War. As the military options succeeded, the equity markets recovered and the oil price fell back. In this case, market moves were largely a function of oil prices rather than the threat of wider damage.
For now, global markets have moved very little, with even the Korean Kospi equity index only 4% off its highs. It is possible that equity markets would be higher without these tensions but the Korean market traders are closest to the action and the market indicates that they are not showing much sign of concern so far.
What makes the situation in Korea different and, indeed, more serious is the nuclear threat and the possibility of a China-US confrontation. That being said, all of these examples show that war or the threat of war can cause markets to sell off in varying proportions but they tend to recover after it is over. The lesson for long term investors is not to panic if the markets sell off and try and look through the present difficulties.