Shaking it Off: The Markets and Geopolitical Crises
When all the world seems to be going to hell, what should a prudent investor do?
Hold tight or buy seems to be the answer, in most situations. For those with a long-term term horizon, equity investments made right before times of geopolitical stress generate returns roughly in line with long-term averages. And those made shortly after the time of the initial shock often realize outsized returns.
That’s not an argument for trying to time the market. That rarely works, as most investors struggle to time both the sale and the repurchase of stocks – and even perfect market timing barely outperforms buying and holding. But it is an argument for staying calm and focusing on long-term goals.
Look at the data. U.S. equity returns since World War I (as measured by the Dow Jones until 1957 and the S&P 500 thereafter) rode out revolutions, terrorist attacks and global pandemics. But not immediately: The initial drawdown averaged 13.4% and around 90 days, as illustrated below. But average returns across these events over the subsequent six months, and one, three and five years were all positive (see the chart below). Clearly, longer-term market returns during periods of geopolitical upset are most related to the underlying economic conditions and valuations at the time.
The 1950s and 1960s were generally robust economic times in the United States. Consequently, the markets rose steadily, even after the outset of a hot war in Korea and through the rising Cold War tensions that culminated in the Cuban Missile Crisis, a threat that felt existential to many. The markets were recovering from a decade of high inflation when the Shah of Iran was overthrown in 1979 – and they continued to do so.
Conversely, the markets were still reeling from the dot.com crash ahead of the 2001 attacks on the United States. Consequently, the sharp selloff when U.S. markets reopened on September 17 after a seven-day suspension was only a small part of the story, as the tech-led bear market was at that point only part way toward its bottom – eventually hitting its nadir in October 2002. And during the global COVID-19 pandemic, which generated many geopolitical consequences, investors quickly turned their attention to the tech and productivity boom. The S&P 500 plunged 34% when the outbreak reached the United States, then it rose 65% over the remainder of 2020.
So, what are the exceptions to this market sangfroid? Or rather, what are the conditions that make for exceptions? And are the hot wars waging in Europe and the Middle East, the coming U.S. election, or something else in the works potential candidates for long-term disruption? Events that have changed or can change the trajectory of global economic growth and/or inflation, and therefore corporate earnings, are the ones that can cause long-term damage in the markets. They are few and far between, but the damage is generally considerable. In these cases, investors’ time horizons would have to be long, as the drawdowns lasted a year or more, and market returns for even three and five years were well under expectations. But again, long-term investors were generally better off staying in the market.
The two world wars, to take the most obvious examples, changed the course of trade, production, and the labor force for a large portion of the globe. The U.S. stock market, then best measured by the Dow Jones Industrial Average, took 18 months to recover from the start of the “War to End All Wars”. Twenty-four years later, in 1939, the Dow Jones actually rose 15% over the seven trading days after Germany’s invasion of Poland, as investors bet that U.S. corporations would benefit from selling arms and other goods to the European combatants. Reality had set in by 1940, when Germany overran Belgium and France, signaling that the war would be long, and would include the United States. Interestingly, the market began its rebound just a few months before the Battle of Midway, in June 1942, a sign perhaps that the investors in aggregate this time around were able to intuit the eventual outcome, well before many of the pundits of the day.
Another example of a geopolitical conflict that caused significant economic and market disruption was the 1973 Arab-Israeli War, also known as the Yom Kippur War. The related oil embargo imposed by the Arab Organization of Petroleum Exporting Countries, or OPEC, hit the United States economy where it hurt, and the S&P 500 lost over 40% in the following 12 months. It is important to note that this is unlikely to happen today, at least not in the United States, which is now energy independent and a net exporter of petroleum products.
At present, we have no reason to count either the war in Ukraine or the Middle East, as horrific as they are, among the few events in which the appropriate response would be to sell or to take on the expense of hedging equity portfolios. That’s true too for the coming and remarkably unpopular U.S. election. One potential long-term disrupter that does come to mind is a Chinese invasion of Taiwan, home to most of the world’s high-value semiconductor manufacturing. To us, this seems a possible but not probable event, and one that can best be protected against through appropriate portfolio diversification.
For long-term investors, there have been very few political shocks to which the appropriate response would have been to sell equities. Let’s hope it stays that way.
Brian Pollak is a Partner and Portfolio Manager at Evercore Wealth Management. He can be contacted at brian.pollak@evercore.com.
Evercore Wealth Management, LLC ("EWM") is an investment adviser registered with the U.S. Securities and Exchange Commission under the Investment Advisers Act of 1940. EWM prepared this material for informational purposes only and should not be viewed as advice or recommendations with respect to asset allocation or any particular investment. It is not our intention to state or imply in any manner that past results are an indication of future performance. Future results cannot be guaranteed and a loss of principal may occur. This material does not constitute financial, investment, accounting, tax or legal advice. It does not constitute an offer to buy or sell or a solicitation of any offer to buy or sell any security/instrument, or to participate in any trading strategy. The securities/instruments discussed in this material may not be suitable for all investors. The appropriateness of a particular investment or strategy will depend on an investor’s individual circumstances and objectives. Specific needs of a client must be reviewed and assessed before determining the proper investment objective and asset allocation which may be adjusted to market circumstances. EWM may make investment decisions for its clients that are different from or inconsistent with the analysis in this report. EWM clients may invest in categories of securities or other instruments not covered in this report. Descriptions provided in this material are not substitutes for disclosure in offering documents for particular investment products. Any specific holdings discussed do not represent all of the securities purchased, sold or recommended by EWM, and the reader should not assume that investments in the companies identified and discussed were or will be profitable. Upon request, we will furnish a list of all securities recommended to clients during the past year. Performance results for individual accounts may vary due to the timing of investments, additions/withdrawals, length of relationship, and size of positions, among other reasons. Prospective investors should perform their own investigation and evaluation of investment options, should ask EWM for additional information if needed, and should consult their own attorney and other advisors. Indices are unmanaged and do not reflect fees or transaction expenses. You cannot invest directly in an index. References to benchmarks or indices are provided for information only. The securities discussed herein were holdings during the quarter. They will not always be the highest performing securities in the portfolio, but rather will have some characteristic of significance relevant to the article (e.g., reported news or event, a new contract, acquisition/divestiture, financing/refinancing, revenue or earnings, changes to management, change in relative valuation, plant strike, product recall, court ruling). EWM obtained this information from multiple sources believed to be reliable as of the date of publication; EWM, however, makes no representations as to the accuracy or completeness of such third party information. Unless otherwise noted, any recommendations, opinions and analysis herein reflect our judgment at the date of this report and are subject to change. EWM has no obligation to update, modify or amend this information or to otherwise notify a reader thereof in the event that any such information becomes outdated, inaccurate, or incomplete. EWM’s Privacy Policy is available upon request. EWM is compensated for the investment advisory services it provides, generally based on a percentage of assets under management. In addition to the investment management fees charged, clients may be responsible for additional expenses, such as brokerage fees, custody fees, and fees and expenses charged by third-party mutual funds, pooled investment vehicles, and third-party managers that may be recommended to clients. A complete description of EWM’s advisory fees is available in Part 2A of EWM’s Form ADV. Trust services are provided by Evercore Trust Company, N.A., a national trust bank regulated by the Office of the Comptroller of the Currency and/or Evercore Trust Company of Delaware, a limited purpose trust company regulated by the Delaware State Bank Commissioner, both affiliates of EWM. Custody services are provided by Evercore Trust Company, N.A. The use of any word or phrase contained herein that could be considered superlative is not intended to imply that EWM is the only firm capable of providing adequate advisory services. This material does not purport to be a complete description of our investment services. This document is prepared for the use of EWM clients and prospective clients and may not be redistributed, retransmitted or disclosed, in whole or in part, or in any form or manner, without the express written consent of EWM. Any unauthorized use or disclosure is prohibited. The Chartered Financial Analyst and CFA trademarks are the property of CFA Institute. Certified Financial Planner Board of Standards Inc. owns the certification marks CFP®, Certified Financial Planner™ and CFP® in the U.S.
IRS Circular 230 Disclosure:
Pursuant to IRS Regulations, we inform you that any U.S. Federal tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for (i) the purpose of avoiding IRS imposed penalties or (ii) promoting, marketing, or recommending to another party any transaction or matter addressed herein. This information is provided for information purposes only and does not constitute financial, investment, tax or legal advice.
©2016 Evercore Wealth Management LLC. All rights reserved.
