Don’t Fool Yourself

• Despite a number of headline-grabbing crises, world stocks and the S&P 500 are up strongly for the year.
• Crises can incite near-term market volatility, but they don’t always result in market calamity.
• History provides plenty of examples of strong market returns despite seemingly world-changing events.
• Crises come and go year after year, and it’s important to use perspective and knowledge to avoid overreacting.

It’s only April 1^st, and so far this year, there’s been unrest (and some government coups) in the Middle East and North Africa, a destructive earthquake and tsunami in Japan, ongoing concern of nuclear fallout, continued PIIGSdebt problems, and fears of a eurozone collapse. There could even be more crises to come—after all, history shows there’s never truly a dull moment.

With such scary events and uncertainties, perhaps you’d think markets have been dinged accordingly—markets seem to pull back sharply right after such events. But you’d be wrong. The MSCI World is still up for the year, and the S&P 500 came close to its best first quarter gain since 1998. What does all of that mean? In the short term, investors may at react out of sentiment, but as crises and their real impact become clearer and better understood, fundamentals tend to regain primacy. Time provides perspective.

Fact of the matter is scary things are a constant in the world. Hardly a year goes by without some seemingly terrifying and potentially market-moving crisis. For example, last year we had PIIGS debt contagion fears and the May “Flash Crash,” but the MSCI World ended the year up 11.8%. This particular listof global crises goes back 15 years, but why stop there? Weren’t the Russian ruble crisis and the Long-Term Capital Management debacle terrifying in 1998? But the MSCI World still rose 24% that year. Here are some (of many) other examples:

• World stocks were up 18.3% in 1991 when Iraq invaded Kuwait and kicked off the first Gulf War.
• World stocks rose 11.0% in 1979 when oil prices skyrocketed, Three Mile Island made headlines, and Iran seized the US embassy in Tehran.
• And perhaps one that many don’t realize (and most don’t remember)—global markets were up 18.7% in 1941—the same year Japan attacked Pearl Harbor, Germany invaded the USSR, and the US declared war on the Axis powers.

Now, that’s not to diminish the human and economic impact of crises—crises are often very tragic events. However, for investors, it’s important to remember crises don’t always turn into a market disaster or derail overarching positive economic fundamentals. Sentiment-driven near-term volatility surrounding crises can often fool investors into thinking these events are more impactful long term than they really are. When something seemingly huge hits, it’s important to assess how it stacks up against fundamentals. Does the event truly change underlying fundamentals to own stocks overall? Or maybe just some stocks? Another important consideration: Is the long-term outcome even knowable with the information you currently have? If not, you could you be making a knee-jerk decision. Those rarely work out well for the long term—especially if the event doesn’t have impact as initially feared and stocks rebound sharply.

Crises come and go year after year and will no doubt continue to make headlines. In the meantime, markets will continue to be resilient.

Note: Returns from 1970-2010 reflect the Morgan Stanley Capital International (MSCI) World Index, which measures the performance of selected stocks in 24 developed countries and is presented inclusive of dividends and withholding taxes. Returns prior to 1970 are provided by Global Financial Data Inc. and simulate how a world index, inclusive of dividends, would have performed had it been calculated back to 1934.