NEW YORK (MarketWatch)—The occasional hiccup aside, investors practically laughed off rising tensions between Russia and the West—as well as other geopolitical turmoil—in August. Strategists wonder how long that can continue.
“They say talk is cheap, but the nature of the rhetoric from both sides makes a peaceful outcome to this standoff highly unlikely in the short term, and the fear is that a careless comment here or there could well set off a further escalation in tensions, which for now markets seem fairly sanguine about.,” said Michael Hewson, chief market analyst at CMC Markets in London.
NATO on Friday said Russian troops had “illegally crossed the border” into Ukraine in a ”blatant violation” of the country’s sovereignty. The Kremlin denies any Russian troops have entered Ukraine to support pro-Russian separatists. Russian President Vladimir Putin directly praised the separatists Friday, while using the term “Novorossiya,” or New Russia, a tsarist-era reference to territory that now includes parts of Ukraine.
European Union leaders will agree to new sanctions on Russia as they meet this weekend, European Commission President José Manuel Barroso and French President François Hollande said on Saturday.
Ukraine’s president, Petro Poroshenko, pleaded for a strong EU response, telling reporters in Brussels that thousands of foreign troops and hundreds of foreign tanks are now in Ukraine territory. NATO released stellite images on Thursday that showed what the Western military alliance described as Russian tanks and other military equipment moving in eastern Ukraine.
U.S. stocks shrugged off the headlines Friday, with the S&P 500 SPX, +0.33% setting the latest in a string of record closes to cap its strongest August rise in 14 years. Even European stocks, which have faltered this year, rose in August, with the Stoxx 600 index SXXP, +0.28% seeing its strongest monthly rise since May.
Oil traders remained focused on a supply glut, falling for a second consecutive month in August.
Strategists question whether market participants can continue to brush off the tensions, particularly as concerns appear to be taking a bigger toll on business sentiment in Europe. Exports to Russia account for around only 1% of German gross domestic product. But analysts say the impact on sentiment could still prove outsize.
“Currently it is more about mood being impacted. But from what we have noticed in various talks with various companies, investment decisions are being delayed, which could intensify on further sanctions. As a result employment growth will come down and economic growth will stall,” wrote Heino Ruland, strategist at Ruland Research in Eppstein, Germany, in a note. “Not yet there, but nor to be ruled out.”
The concerns over Russia come as the European Central Bank weighs additional stimulus measures, including the possibility of outright quantitative easing, amid persistently below target inflation readings as the region’s recovery falters.
Emerging markets could bear the brunt of a worsening conflict. The iShares MSCI Emerging Markets ETF EEM, -0.16% is up 7.8% year-to-date, bouncing back from a January stumble on worries over the so-called “fragile five” countries.
Matt Weller, senior technical analyst at Forex.com, said a weak HSBC Chinese services purchasing managers index reading on Wednesday combined with worsening Ukraine tensions could deliver a double whammy.
If the index were to fall below the 50 level—signaling a contraction in activity—emerging markets would likely come back under pressure. “That means a potential stock market selloff, safe haven currency strength, and a rip-roaring start to the post-summer trading season,” he wrote. “If the Russia/Ukraine conflict were to turn more significant as well, this week could get pretty ugly.”
Will U.S. investors care? Strategists argue that while global turmoil may become tougher to ignore, the ability of U.S. stocks to keep pushing higher in the face of growing turmoil puts the burden of proof on the bears.
“Keep in mind that the bull market is aging, but until we see signs of sustained distribution (heavy selling) the market deserves the bullish benefit of the doubt,” wrote Adam Sarhan, chief executive of Sarhan Capital, in a note. “Furthermore, the S&P 500 has not experienced a 10% correction since 2012 which is longer than most historical comparisons and illustrates how strong this bull market is.”