One of the concerns for investors is how markets keep powering higher despite all of the geopolitical turmoil: the grinding Syrian civil war that has spilled into Iraq, the clash between Israel and Gaza, the Crimea annexation and now the confrontation between Russia and Ukraine.
That thinking gets the issue precisely backward. The proper question to ask is, “Why should investors care about geopolitics?”
That may seem counterintuitive, but if you delve into history, you will discover that markets have more or less found the normal turmoil of geopolitics to be irrelevant. The reasons for this are varied, but consider these factors:
1) Most geopolitical events don't affect corporate revenue and earnings. Even trade restrictions tend to cause consumption to shift as opposed to going way (though there are, of course, some exceptions).
2) Despite the big bold headlines, most of these events are relatively small from a global economic perspective. Take the Russian-Ukraine skirmishes. Ukraine’s annual gross domestic product is equal to about two days of U.S. GDP.
3) Markets tend to anticipate large events; by the time news breaks, many key investors have already made adjustments to their holdings. “Buy the rumor, sell the news,” is another way of saying the news is already reflected in stock prices.
Hence, “Lose the News” is often good advice for longer-term investors.
When we look back at historically important geopolitical events, we tend to see similar patterns. Markets will wobble on the news, especially more surprising events like Pearl Harbor, Sept. 11 or the Kennedy assassination. Post-wobble, markets tend to resume their prior trend.
Only extreme global events such as World War II slow markets, and even those occasions display similar patterns. After the 1931 low in the Dow Jones Industrial Average of 40.56, the index rose almost fivefold by 1937 to 195.59. In the next few years, when it looked as if the U.S. would get dragged into the war, the Dow was cut in half, falling to 92.69. After the attack on Pearl Harbor, the U.S. entry into the war did nothing to slow market gains. By 1946, the Dow had surpassed its prewar high, tagging 213.36. Ten years later, the Dow had reached 524.37.
Events that don't have much of an economic component, but may be shocking to the public, like the JFK assassination in 1963, show the pattern quite clearly. Markets that are rising may pull back, but then they resume their earlier direction.
Before the 9/11 attacks, the U.S. was already in a recession that started in March of that year. Markets had peaked in March 2000, 18 months before the attacks, and the dot-com bust was still playing out. The terror attacks did close the New York Stock Exchange for five days. When it reopened, there was a huge sell-off, followed by a bounce, then a resumption of the earlier downward trend.
The opposite pattern can be seen after the start of war in Iraq in March 2003. Markets reached their low a few days before the U.S. invasion began, then almost doubled during the next four years.
However, when events have a very specific economic component, such as the Arab oil embargo of 1973-74, we can see significant changes to inflation, consumer spending and corporate earnings. Oil rose from about $3 a barrel to almost $12 in a few months, triggering a recession.
This isn't a cherry-picked list -- just look at the nature of a major geopolitical event and you will find this pattern is fairly consistent, and for the reasons we mentioned.
Investors who read the daily news should do so for informational purposes only. Those who trade on them are often late to the party.
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