How should you respond to the crisis in Iraq?

The headlines are all about the tragic events in Iraq at the moment.

The extremist group, Isis, has made remarkable gains.

Some argue that this proves that we should never have invaded Iraq in the first place. Others (like myself) think that the decision to pull out all troops at the end of 2011 is responsible for the collapse.

But whatever your interpretation of the past, we need to figure out how this latest Iraq crisis will affect global markets in the future.

Could the latest crisis spark a wider conflict, sending oil prices soaring? Or are these fears overblown?

And do you need to take any measures to protect yourself?

Why is this taking place?

We’ll be taking a more detailed look at the causes of the events in Iraq in this week’s magazine. (You can subscribe to MoneyWeek magazine to MoneyWeek magazine here.)

However, there are three main reasons for the current crisis.

Firstly, Iraq is a country divided along religious lines. While most Iraqis are Shia Muslims, there are significant numbers of Sunni Muslims (along with Kurds and a small Christian population). Saddam Hussein’s regime heavily favoured the Sunni minority while the Sunnis now claim that the current government has been doing the same thing in reverse.

The second factor is the influence of external countries. Since Saddam’s fall, several regimes (especially Iran and Syria) have supported terrorist groups.  Ironically, many of these terrorist groups ended up turning on their former masters. This is most apparent in the case of Syria, where Isis now controls a swathe of the Syria/Iraq border. The Syrian conflict is now spilling over into Iraq.

Finally, there is evidence that some of the Gulf States, such as Saudi Arabia, are backing Isis in order to counter Iran.

So is this a threat?

It’s clear that Isis has made tremendous gains. However, the Iraqi government still has a large advantage in terms of material, soldiers and funds. Large numbers of civilians have also joined up. Iran has also sent a small number of special forces.

What’s more, while the US has not formally made a decision, it looks like these events will force it to expand support for Nouri al-Maliki’s government, and launch some form of air campaign.

Already there is evidence that Baghdad has halted the Isis advance and forced them onto the defensive. It’s also important not to overstate importance of sectarian factors. While Sunnis may not like Maliki, most of them don’t want anything to do with the insurgents.

All this means that the most likely outcome is a prolonged insurgency in parts of the country, not the immediate implosion of Iraq. Isis probably won’t seize Baghdad.

What this all means for investors

So, should investors panic and sell all their shares?

Well, there are plenty of reasons to think twice about certain markets. For instance, the US is trading at a sky-high Cape ratio of over 25. Other measures, such as price-to-book value (price relative to net assets) and Tobin’s Q (the cost of replacement capital) tell a similar story.

So, there are good reasons to fret about US share prices, but the Iraq crisis probably isn’t one of them.

And overall, there’s no reason to dump shares in general, since the wider impact (in terms of markets) is likely to be limited. Indeed, studies suggest that investors have a tendency to overreact to bad headlines. So, you might want to look at the cheaper markets, like Ireland and Greece.

As for oil, the oil prices have gone up in the past few days to the highest levels since last September. If prices rise further and stay at higher prices for some time, we could see a modest slowdown in economic growth.

However, the impact of the crisis on the oil market is likely to be smaller than some people expect.  Remember that most of Iraq’s oilfields remain in either the government’s hands, or are controlled by the Kurds. In any case, Iraq’s production lags behind that of Saudi Arabia and Iran. Thanks to the fracking-related oil boom, Iraq produces less than 40% of the US’s output.

I fear that we’re going to see more horrifying pictures from Iraq in the weeks ahead, but investors should stay calm.

• This article is taken from our free daily investment email, Money Morning. Sign up to Money Morning here.

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  • JW

    Mmm. If pulling out the troops in 2011 caused the collapse, then surely, by not invading the sovereign state in the first place we could have avoided the problematic withdrawal! QED.

  • 4caster

    Not QED at all. Arguably we should have finished the job in 1991, because Saddam was a nasty piece of work who went on to use poison gas on his own Kurds, and attempted genocide against the Marsh Arabs in SE Iraq.
    Consider the analogy of Germany. We didn’t finish the job in 1918, but imposed impossible reparations instead, thereby sowing the seeds of World War 2. Then we did finish the job in 1945, and kept troops there, not for 8 years as in Iraq, but until the end of the Cold War against the USSR. Indeed some are still there after nearly 70 years. We remained, not to subdue the Germans, but to protect them and ourselves against the Soviet threat.
    Regrettably we allowed Iraq to have a constitution that provided a majority Shia government, with insufficient safeguards for Sunni minorities (and Christians and Jews): hence the disaffection of the Sunnis between Syria and Baghdad.

  • JW

    Yes, we probably should have removed Saddam from power in 1991 – not necessarily by hanging him though. He had invaded a sovereign state and the world was justified in stopping him, not least for reasons of energy (oil) security. We would probably have made bad decisions in 1991 even if we “finished the job”, just like we always seem to do in that part of the world. However, I don’t think we had legitimate reasons to invade in 2003. Don’t forget also, that Saddam was a friend/ally during the Iraq/Iran war of the 1980s. Our (the West) political dealings in the region have always been murky! Not sure about the German analogy though. You are comparing different peoples, different eras and different agendas, amongst other things. In investment speak, you are not comparing apples with apples.