17 Apr 2024 Geopolitics and The Stock Market

There are many risks that we face as investors. The last 36 months have reminded us of the risk that inflation poses, not just to lifestyle, but to our fixed income investments. The COVID-19 pandemic, which began a little over four years ago, is another example of risk. While the form and severity of risk will change, we should never expect it to fade completely into the background.

Most recently, geopolitical risks have taken center stage. Russia invaded Ukraine a mere 26 months ago; Hamas launched a terrorist attack against Israel, our most reliable ally in the Middle East, last October; this past weekend, Iran dispatched more than 300 drones and missiles in a direct attack against that same ally.

It’s normal to feel worry in times like these, especially if you or a family member serves in the military of if a loved one is in harm’s way. Like me, you might find yourself reviewing a mental checklist anytime something like this occurs: Is my family ok? My friends? Anything we need to do to weather this? Our checklists will look different, but somewhere on there are our finances: How might (insert event) impact my income? My portfolio?

Which raises the question: How much of an impact do these events have on the stock market? Let’s take a look:

You will notice immediately this list excludes wars (more on war’s impact later) and focuses on what it calls “shock events.” You might also notice that the COVID pandemic is missing, which is merely a result of when the chart was created. Outside of the pandemic, which caused markets to fall more than 31% in five weeks, none triggered a bear market (loss of 20% or more) and most caused a total drawdown of less than 7%. The average drawdown is 5% and a full recovery takes less than two months (the COVID recovery took five months). Pretty minor impacts.

Switching from “shock events” to only incidents with military involvement, we see something similar:

This chart shows us:

1. 1. Impact varies;
   2. The time-frame leading up to the event can actually be tougher on stocks than the days and months following the event;
   3. Most events have a limited impact;
   4. The impact is typically short-lived.

What if a conflict expands and war breaks out? A 2011 study had this to say: (R)esearchers at the Swiss Finance Institute looked at U.S. military conflicts after World War II and found that in cases when there is a prewar phase, an increase in the likelihood of war tends to decrease stock prices, but the ultimate outbreak of war increases them. However, in cases when a war starts as a surprise, the outbreak of war decreases stock prices. They called this phenomenon “the war puzzle” and said there is no clear explanation for why stocks increase significantly when war breaks out after a prelude.

Ben Carlson, who we quote often, adds this: “From the start of World War II in 1939 until it ended in late 1945, the Dow was up a total of 50%, more than 7% per year. So, during two of the worst wars in modern history, the U.S. stock market was up a combined 115%. The relationship between geopolitical crises and market outcomes isn’t as simple as it seems.”

I would add that the relationship between most events–geopolitical or otherwise–and market outcomes isn’t as simple as it seems, which makes our response so important.

So what’s the correct response? In the aftermath of the U.S. airstrike that killed Iranian general Qasem Soleimani (one of the “shock events”), John Lynch, a strategist with LPL Financial, said: “As serious as this escalation is, previous experiences have indicated it may be unlikely to have a material impact on U.S. economic fundamentals or corporate profits. We would not be sellers of stocks into weakness related to this event, given stocks have weathered heightened geopolitical tensions in the past.” The data backs him up.

We would say something similar (though in not nearly as stuffy language). The correct response is to do nothing. Sit tight. Ride it out. The data tells us that the stock market handles events like this surprisingly well, and the more we allow our emotions to guide our investment decisions, the greater the risk that we miss out on stock market gains.

Of course, data isn’t always helpful when we’re worried or anxious. What does? Talking about it. Risk will always be a part of investing, so no matter the risk, we hope you will reach out to us anytime you’re feeling uncomfortable.

The content above is for informational and educational purposes only. The links and graphs are being provided as a convenience; they do not constitute an endorsement or an approval by Beacon Wealthcare, nor does Beacon guarantee the accuracy of the information.