· During bull markets, investors frequently worry about what could cause the next bear market.
· Diplomatic talks with Iran over nuclear weapons and a series of natural disasters are causing recent investor jitters.
· Because it's impossible to predict the scope of potential future attacks or disasters, predicting their market impact is also difficult—investors shouldn't assume a bear market automatically follows.
In the face of a new bull market, investors are often wary of the next big revelation that could topple the rally. Terrorist attack? Geopolitical unrest? Natural disaster? The ambiguous nature of these threats and their potential to happen at any time is a tough fear to shake.
This week's high-tension talks over Iran's recently disclosed nuclear facility coupled with the destructive natural disasters in Samoa and Indonesia may be causing recent investor jitters. Because it's impossible to predict the scope of potential future attacks or disasters, predicting their market impact is also difficult. But instead of constantly fearing the worst, investors should turn to history as a benchmark for how markets might react should something similar occur.
First, conflict in the Middle East has been ongoing for as long as capital markets have existed—far, far longer even—and the world, and markets, have marched on in spite of it. Does that guarantee the same outcome in the future? Of course not, but it's worth remembering as context.
Similarly, we can analyze other out-of-the-blue, highly destructive events to see how markets handled them. The tragic events of 9/11—an attack that struck the heart of Wall Street—occurred two-thirds of the way through a bear market. When stock markets reopened on September 17th, a steep drop ensued, and the S&P 500 eventually fell over 11%. But markets were back at pre-attack levels within three weeks and remained above those levels for months.* The short-term effect, where uncertainty was sky-high, was a negative, but once things settled, markets realized this profound human tragedy simply wasn't enough to derail global markets.
Within the next five years, Madrid and London experienced massive train bombings, and the British narrowly averted terrorist plots to plant liquid bombs on 11 flights headed to the US. The subsequent market impact of these events was relatively minimal. Historical analysis of the aftermath of these events begs the question: Have stock markets, as discounters of widely known or expected information, already priced in the next attack? Or, said differently, are we living in a world more anesthetized to such attacks, at least from a market perspective? Possibly.
Natural disasters have similar historical market track records. Hurricane Katrina wreaked havoc on America's Gulf Coast region, namely in Louisiana. The following day and subsequent quarter saw positive US stock market returns, if only by a little. US GDP grew by 1.8 percent for the fourth quarter that year, in the face of widespread concern over the lasting economic impact of the disaster.* It's impossible to prove if markets, or the economy, could have done better without the impact of Katrina and the 2005 hurricane season.
The lessons: Massively destructive events (manmade or natural) are always a threat, but they must be sufficiently huge, particularly in today's increasingly connected world, to derail global markets. As in World War scale huge. In that context, today's worries over Iran's nuclear capabilities shouldn't be taken lightly, but also must be recognized for what they are—as of today, nothing that yet has the power to cause a new global bear.
The importance of this perspective is vital—for long-term investors to turn defensive at the sniff of every geopolitical conflict would mean jumping in and out of the market constantly, incurring not only huge transaction costs, but also missing out on huge chunks of bull markets, and thusly consistently underperforming.
Fact is, while a major global event always carries the potential to impact stock markets, worrying about worst-case scenarios doesn't accomplish much except lost sleep. Proof of what causes market activity, on the upside or downside, is hard to come by—so even if a disaster occurs, don't assume a bear market automatically follows.
* Thomson Financial Datastream