This Little Piggy

Story Highlights:

• The swine flu outbreak may or may not have contributed to Monday's overall market drop, but sector performance suggests it had some impact.
• Events like the swine flu outbreak have initial surprise power and often evoke immediate investor reaction. But these events and their effects are typically more short-lived than initially anticipated.
• Investors selling stocks over swine flu fears is an example of markets trading on fear-based sentiment, not fundamentals.
• As it becomes apparent these concerns are unwarranted, associated stock market disruptions should reverse, creating opportunities for clear-headed investors.

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The pigs of our childhood were tame compared to today's. In the old days, they went to market, stayed home, had roast beef (or not), and cried "wee, wee, wee" all the way home. Today, they transmit infectious influenza and, in the minds of some investors, dampen business activity and depress stock prices. Well, the swine flu outbreak may or may not have contributed to Monday's overall market drop—sector performance suggests it had some effect—but there's likely to be little, if any, lasting economic and market impact.

Events like the swine flu outbreak have initial surprise power and often evoke immediate investor reaction. Investors fear these events will disrupt business activity and end up very costly economically. But such events and their effects are typically all oink and no bite. For example, the SARS outbreak in 2002-2003 was widely hyped as the next full-blown pandemic and was even thought to threaten China's growth. In the end, SARS resulted in fewer than 800 deaths across 25 countries—tragic, but far from the feared pandemic. And though by some estimates it cost the Asia Pacific region $40 billion, the region did fine economically in the years following. In fact, China has maintained very strong GDP growth since the SARS outbreak.

Investors selling stocks over swine flu fears is an example of markets trading on sentiment, not reality. Pandemics are actually very rare—modern technologies and information sharing greatly help curb the spread of infectious diseases. (The last real pandemic was the Hong Kong flu outbreak in 1968-1969.) Take today's fearful market reaction and extend that to fears over another Great Depression, or of the next "shoe to drop" in Financials, or any other number of recent worries, and you can see why stocks have been pushed down as far as they have been. As it becomes apparent these concerns are unwarranted, associated stock market disruptions should reverse, creating opportunities for clear-headed investors.

In the short term, markets can move on warranted and unwarranted worries. But they'll discount events' true impact before long. Because of this, selling or buying based on sentiment can lock in unnecessary losses or otherwise produce inferior portfolio results. The swine flu will no doubt hog headlines a little while, but prudent investing means seeing beyond initial sentiment reactions. After all, investors want to bring home the bacon, not cry all the way home.