Key Takeaways
Because the global economy is interconnected, geopolitical events can have a significant impact on financial markets. Understanding these impacts and having a solid investment strategy can help you navigate periods of uncertainty. It is also important to understand that the vast majority of geopolitical events result in transitory rather than lasting impacts on financial markets. The primary driver behind many market declines and undoubtedly those caused by geopolitical events, is the uncertainty that accompanies such events. Once the uncertainty dissipates, markets generally recover and often do so rather quickly.
This blog post explores the types of geopolitical events that can cause market volatility, their historical impact, and how a value investing approach can help mitigate effects on long-term investment strategies.
To set the stage, below we cover a few specific historical geopolitical events and their initial impact on the markets and the economy followed by market reaction after the initial shock of the event.
- Pearl Harbor Attack (1941)
Short-Term Impact:
Following Japan’s attack on Pearl Harbor on December 7, 1941, the Dow Jones Industrial Average (DJIA) fell over 3% on December 8th and another 2.8% on December 9th. The index dropped 6.5% in four days and reached its lowest level since 1934.Long-Term Impact:
Despite the initial shock, the market began recovering in 1942, buoyed by wartime production and fiscal stimulus. The war effort led to full employment and industrial expansion, which supported equity prices. By 1945, the DJIA had rebounded significantly, reflecting investor confidence in the U.S. economy’s transformation.Economic Context:
The attack catalyzed U.S. entry into WWII, accelerating government spending and industrial mobilization. Roosevelt’s New Deal had already laid the groundwork for recovery, and the war effort further boosted GDP and employment. - Cuban Missile Crisis (1962)
Short-Term Impact:
The Cuban Missile Crisis in October 1962 caused a brief but sharp decline in equity markets. The S&P 500 fell 5% in the first week of the crisis but recovered 4% in the following days.Long-Term Impact:
A broader market decline, known as the “Kennedy Slide,” began in December 1961, prior to the Cuban Missile Crisis, and lasted until June 1962, with the S&P 500 dropping 22.5%. Recovery began after the crisis ended, aided by margin requirement reductions and tax cuts.Economic Context:
The crisis occurred during a period of rapid economic expansion. Investor fears of nuclear war were short-lived, and confidence returned as diplomatic resolution prevailed. The episode underscores how markets can rebound once uncertainty dissipates. - September 11 Attacks (2001)
Short-Term Impact:
Markets closed for four trading days. Upon reopening on September 17, the DJIA fell 684 points (7.1%), and the S&P 500 dropped 11.6% over the week. An estimated $1.4 trillion in market value was lost.Long-Term Impact:
Despite the immediate sell-off, markets recovered in subsequent months. Over the next two decades, the S&P 500 quadrupled in value, reflecting long-term resilience.Economic Context:
The attacks exacerbated an existing recession and led to increased defense spending. Airline and insurance sectors suffered, while defense and tech stocks gained. The Federal Reserve injected liquidity to stabilize markets, demonstrating the importance of policy response.
Geopolitical Events and Market Volatility
As seen in the above examples, geopolitical events can trigger market volatility due primarily to increased uncertainty. This uncertainty can cause investors to reassess risks and adjust their portfolios, often hastily and without due consideration to the bigger picture. Additional examples of market rattling geopolitical events follow.
Military conflicts and wars
Military conflicts and wars can disrupt global trade, increase uncertainty, and lead to rapid fluctuations in commodity prices, particularly oil. For example, the 1990 Iraq invasion of Kuwait led to a significant oil price spike and market downturn. As a matter of fact, oil prices spiked by over 176% in just a matter of months leading to an unanticipated increase in the cost of energy for businesses and consumers. This reallocation of economic resources to pay the higher energy costs adversely impacted many industries and created significant volatility in the stock market.
Trade disputes and sanctions
Disputes can impact global supply chains, increase costs for businesses, and reduce economic growth. The U.S.-China trade war in 2018-2019 caused periodic market volatility as investors reacted to each new development.
Political instability or regime changes
Unexpected political shifts can create uncertainty about future economic policies, which in turn affects investor confidence. The Brexit referendum in 2016 led to immediate market drops in the UK and Europe.
Major policy shifts in influential countries
Changes in monetary or fiscal policy in major economies can ripple through global markets. The 2013 “taper tantrum” was caused by the U.S. Federal Reserve’s announcement of reduced bond-buying, leading to significant market volatility.
Global health crises
Pandemics can disrupt economic activity on a global scale. The COVID-19 outbreak in 2020 caused one of the fastest market declines in history, followed by a rapid recovery. The recovery occurred so quickly, that equity prices had largely regained their pre-pandemic levels in a matter of months.
The Transitory Nature of Geopolitical Impact
Although geopolitical events often trigger swift market responses, history shows their effects are typically short-lived. For example, from the end of World War II through 2022, there have been 18 significant “acts of war.” On average, the S&P 500 experienced a sell-off of 6.2% during these events, but markets typically recovered within 30 trading days.
The severity and duration of market impacts can vary. Events that significantly disrupt energy markets and supply chains, such as the 1973 Arab oil embargo, the 1990 Iraq invasion of Kuwait, and the Covid-19 pandemic tend to have more prolonged effects due to their broader economic implications.
Despite initial turbulence, markets have shown remarkable resilience. For example, a survey of various studies has shown that approximately one year after a geopolitical event, markets bounce back between 7% and 10% around at least 65% of the time. This data underscores the importance of maintaining a long-term perspective during periods of uncertainty. That’s where value investing comes in.
The Value Investing Advantage
Value investing is an investment strategy that focuses on identifying and buying securities that appear underpriced based on fundamental analysis. This approach involves:
- Analyzing financial statements to assess a company’s intrinsic value based on their cash flows
- Comparing the intrinsic value to the current market price
- Investing in companies trading significantly below their intrinsic value
- Holding these investments long-term, waiting for the market to recognize their true value
Research has consistently shown that value investing outperforms traditional investment strategies over the long term (10-20 years). For example:
- Value stocks have outperformed growth stocks by an 3% to 4% annually since 1927.
- Research by Lakonishok, Shleifer, and Vishny (1994) demonstrated that value strategies yielded higher returns across various holding periods, with the outperformance increasing for longer holding periods.
The focus on value investing through fundamental analysis and a long-term perspective aligns well with navigating most of the geopolitical uncertainties outlined above.
Why Value Investing Works in Turbulent Times
By investing in companies with strong balance sheets, consistent cash flows, and attractive valuations, investors can build resilient portfolios that can weather short-term market disruptions. Value investing can be particularly effective during periods of geopolitical uncertainty for several reasons:
- Margin of safety: Value investors seek to buy stocks at a significant discount to their intrinsic value. This “margin of safety” provides a buffer against market downturns and unforeseen events.
- Focus on fundamentals: Emphasizing a company’s financial health and long-term prospects helps investors avoid panicking about events with limited long-term impact.
- Contrarian approach: Value investors often go against market trends, buying undervalued assets when others are selling. This can be advantageous during crises when markets usually overreact as detailed in the numerous examples above.
- Long-Term perspective: Value investing encourages a long-term view, which aligns well with the historical tendency of markets to recover from geopolitical shocks over time.
- Diversification: Many value investing strategies naturally lead to diversified portfolios, which can help mitigate the impact of region-specific geopolitical events.
Our Approach at Alpine Private Wealth
At Alpine Private Wealth, we execute a value investing strategy that we believe helps reduce the impact of geopolitical developments on our clients’ portfolios. While such events can influence both stock and bond markets, our disciplined, long-term approach is designed to help cushion portfolios from their short-term effects and support long-term performance. Our focus on fundamentals enables us to prioritize companies with strong financial health and competitive advantages, which are better positioned to withstand economic shocks. By investing in undervalued securities, we provide a margin of safety against potential market downturns.
Our long-term perspective means we don’t make knee-jerk decisions to short-term events. Instead, we stay the steady course. Through diversification, we spread investments across various sectors and market capitalizations to reduce the impact of geopolitical events on the overall portfolio.
Conclusion
Geopolitical events can cause market volatility which is often short-term in nature. But history shows that markets are resilient and tend to recover over time. A value investing approach, with its focus on fundamental analysis and long-term perspective, can be an effective strategy for navigating these uncertainties. By maintaining a disciplined investment strategy and avoiding reactive decisions, investors can work towards achieving their financial goals, regardless of the geopolitical climate. Remember, every investor’s situation is unique. It’s always advisable to consult with a financial professional to discuss how different investment strategies can help you stay focused on your long-term objectives while navigating the complexities of today’s global markets.