How do major geopolitical conflicts affect the ASX 200?

Global equity markets are off to a weak start this October on growing fears about a wider Middle East conflict after Iran launched dozens of missiles towards Israel on Tuesday.

The S&P/ASX 200 is down around 1.0% so far this week while major US benchmarks like the S&P 500 and Nasdaq fell 0.9% and 1.5% respectively on Tuesday night.

While the attack was relatively brief, it dramatically raised the stakes in an already tense situation. World leaders have long cautioned that the conflict between Israel and Iran's proxies – Hamas in Gaza and Hezbollah in Lebanon – could expand into a wider regional war.

In response to the attack, Israel's Prime Minister Benjamin Netanyahu convened an emergency meeting of his security cabinet late Tuesday. "Iran made a big mistake tonight and will pay for it," Netanyahu declared. "Whoever attacks us, we attack them."

The escalation triggered an uptick in demand for safe havens assets like gold and the US dollar, which rose 1.0% and 0.5% respectively overnight. While the CBOE Volatility Index – known as the VIX – jumped 15% to a near one-month high.

While it is difficult to do so during times like these, our job as investors is to assess what impact the conflict might have on the global economy and financial markets. Below, we examine how such crises impact the local sharemarket.

What does history tell us?

Here's a breakdown of ASX 200 returns during major conflicts. Note that the data reflects price returns and not total returns.

Source: Market Index

The data flags notably volatility in the aftermath of conflicts, through to the first three months. Despite initial fluctuations, longer-term performance appears largely unaffected by these events.

Source: Market Index

The big question

The most important factor that influences post-conflict returns is if the war breaks out during a recession or not.

Across the ten conflicts above, three of them have taken place during recessionary periods or times when the US economy was about to enter a recession.

• Iraq-Kuwait War: The Iraqi invasion of Kuwait, which led to the Gulf War, triggered a spike in oil prices from US$15 in June 1990 to highs of US$40 in October. This was compounded by the Fed's tightening cycle in response to rising inflation. During this time, unemployment hit a peak of 7.8% in mid-1992 while GDP contracted about 1.5%.

• September 11 Attacks: The dot-com bubble burst in the early 2000s was the primary driver of this recession, while the 9/11 attacks greatly exacerbated the economic downturn.

• Iranian Airstrike: This event was not responsible for the recession. The COVID-19 pandemic broke out a few months later, triggering a brief yet severe recession.

When the US is in recession, the ASX 200 shows negative average forward returns across all time frames, based on price returns data. It's worth noting that total returns would likely show a slightly improved picture.

Source: Market Index

This leaves us with a rather dynamic situation that hinges on how the economy performs over the near term.