A History of the Way Geopolitics Has Impacted Markets (1941-2021)

History suggests that markets focus on the corporate bottom line and tend to be resilient. JL

Barry Ritholtz reports in The Big Picture:

Working from the Pearl Harbor attack forward, and focusing on market data, the overall impact on stocks and bonds is actually de minimus. There are in all but the most horrific instances (e.g., world wars) only a modest impact on corporate revenues and earnings. Those measures are what drives markets over the long run. Even (after) the US entry into World War 2 after the Pearl Harbor attack, markets were higher in 307 days. Over short time periods, markets react as events lead investors to suffer emotional spasms. And so markets stumble, before returning to their prior trends.

We began this week looking at a broad question: “What is of greater import to investors, reopening post-pandemic, or war in Eastern Europe?” The next day, Vladimir Putin invaded Ukraine. When the US markets opened Thursday, they gapped down nearly 3% amidst 24/7 media coverage. It was reminiscent of the post-September 11^th or the pre-2003 Iraq invasion. The danger today is the “uncertainty” over whether this spills into Eastern Europe, drawing NATO forces into a shooting war with Russia.

After 9/11, I found researching the market impact of geopolitics was a good way for me to cope with that attack.¹

The exercise was a useful distraction: focus on the data while trying to compartmentalize the emotional aspects of that event. Working from the Pearl Harbor attack forward, and focusing on market data, we learn the overall impact on stocks and bonds is actually de minimus. There are in all but the most horrific² instances (e.g., world wars) only a modest impact on corporate revenues and earnings. Those business measures are what drives markets over the long run. Over short time periods, however, markets do tend to react as events lead investors to suffer emotional spasms. And so markets stumble, they wobble a bit, before returning to their prior trends.

Consider the table nearby: On average, the impact of these events is a one-day loss of about 1.1%. The total drawdown from geopolitical events averages -4.8%; and it takes about 19.7 days to bottom and 43.2 days to recover.³

Those numbers may seem a bit abstract, lacking in emotional resonance and immediacy. To create something more resonant, I applied those to Batnick’s framework of “Reasons to sell.”

The result is the instructive chart you see above. Most of the time, markets are hardly affected by these sorts of terrible events. Even the US entry into World War 2 after the Pearl Harbor attack took a little more than one year to recover. The worst war in human history and markets were higher in 307 days (it did take 143 days to bottom).

The lesson here is to never bet against human ingenuity, creativity, or progress. In the face of horrific existential threats, while the headlines are terrible, gradual improvements are always taking place beneath the surface. Morgan Housel likes to say that “Progress happens too slowly for people to notice, while setbacks happen too fast for people to ignore.”

To get to those long-term returns, you must survive the short-term. It’s not always easy amidst all of the noise, but the data can help you navigate the path more objectively.