How Markets React To Crisis: Why Recessions Are Scarier Than Geopolitical Shocks

If you live anywhere other than under a rock these days, no doubt you feel your financial security hangs in the geopolitical balance. And why shouldn’t you? For those Americans who’ve been tracking their 401(k)’s or the market, tuning into the nightly news or the morning paper, or even logging onto Twitter or Facebook, reports of doom and gloom abound. The culprit? Volatile North Korea and threats of global aggression.

Believe me, I get it. It’s scary. And not in the sense that we couldn’t step on North Korea if their bark turned to bite, but scary in the sense that conflict in the world does more than threaten our physical reality. It can threaten our financial reality, too.

But, I’m going to ask you to breathe here. Deeply. Because I’m a financial professional, let’s focus on the money and market piece of today’s geopolitical world.

It will be okay. Let me explain why.

The American economy has withstood equal, if not greater, threats. And each time, no matter the gravity of the global or domestic disaster, we heal relatively quickly.

The North Korea standoff is no different.

For perspective, break out your economic history books with me. Understanding what happens to markets when things get dicey around the world will help alleviate some of your fears.

If the North Korea standoff reminds you of the Cuban Missile crisis, you’re not alone. In 1962 we had a small country dictator (Castro) coordinating with a giant military power (Russia), and some serious puffing of feathers. Now we have a small country, a dictator quasi-backed by a real military (China, perhaps?), and some serious puffing of feathers. Déjà vu?

Let’s keep looking, though. After all, the lessons we learn from history are the sum of all their parts. Take for instance the start of WWII and the Pearl Harbor attack. These were horrific events. They struck fear and grief into the hearts of all Americans. They sent shock waves through the market. But like humans, the market heals.

I know what you’re thinking here. “Wes, this time is different. We’ve never seen anything this crazy before. We’re talking about an undoubtedly crazy tyrant, perhaps backed by a strong nation, with real weapons that could be nuclear.” I hear you. I get it. Believe me, I’m not making short shrift of the insanity of what’s happening. Of course, it’s scary. Of course, things are uncertain. But what I want to do is interject some balance in how we think and feel, especially about our financial future.

Try to think back to some other tragic events that has happened in your lifetime – the Day J.F.K. was assassinated, Vietnam, black Monday in 1987, the Gulf War, or 9-11. Remember feelings around the time of any of these events, before any clear resolution was in sight. Remember feeling like things were out of control.  Remember people playing out every potential worst-case scenario in their heads. Remember the enormous amount of fear, of uncertainty. These feelings are not new. They rear their ugly heads every time there is a threat or occurrence of large-scale tragedy.

No doubt folks are wondering, “Well, if the avalanche does start, and there’s no quick or logical end, what should I do with my investments?  Should I pull out and head for the hills?”

You could, but in the end, that tactic usually works against you.

Markets “shake” they don’t “break.”  

To really understand how markets are impacted by crisis, we need to examine what happens immediately, and over a longer period of time, in this case, over a full year. Over the course of 6 months to a year, history shows us that the vast majority of the time markets show substantial recovery. Markets initially “shake” but given time, don’t “break”.

This is evident when looking at the following historical crisis events:

After the Pearl Harbor attack, markets were down almost 4% in one day. The day J.F.K. was assassinated, markets responded by ending at -3% that day. During the Crash of ‘87, the market was down 20% in a day. On 9-11, markets were down 5% in a day. How about June 24th, 2016, not that long ago, the day of Brexit?  Markets were down almost 4% in one day.

But then, look at what happened only a short time later.

  • Pearl Harbor – one year later markets up nearly 4%
  • JFK Assassinated – 6 months later markets up 16%, and one year later up 24%
  • The Crash of ’87 – 6 months later markets up 15% and one year later up 22%

What if markets haven’t recovered one year later? 

This was certainly the case with September 11th, 2001? After six months, the market had climbed +12%. But a year later markets were 14% lower. Why? Because of a recession caused by the dot com burst.

This is also the case when looking at crisis events like the collapse of Bear Stearns and Lehman Bothers. Markets were negative on each crisis day, and even lower one year later. Like the September 11th example, the market carnage one-year post-Bear Stearns and post-Lehman had to do with a recession – the Great Recession of 2008 and 2009, and not the specific collapses of these institutions.

Bottom Line.

In researching 18 major geopolitical crisis events beginning with Germany invading France in 1940, all the way until Brexit in 2016, here’s what the numbers tell us. On average, daily shocks came in at -3%. From six to twelve months later, markets ended higher by about 2%. Markets may shake when uncertainty hits, but given even a short amount of time, markets typically recover. This average is not only significant, it reinforces the fact that although markets shake, they don’t break when it comes to historical crises.

So, if markets are lower one year later following a geopolitical scare it’s often not due to the geopolitical event itself. For long term stock market damage, the real culprit is almost always an economic recession. The data here is clear. And the good news is that for now, recession clouds still haven’t appeared in the 10-day forecast.

Check Out: 5 Reasons Why You Should Have A Financial Advisor

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