Major political events might be currently impacting upon the performance of the stock market, but just how worried should we actually be?
Stocks suffered their worst day since September yesterday as Wall Street digested the ever increasing turmoil coming out of Washington.
With many Democrats, and even some Republicans, now throwing around the idea of impeachment, it is seeming ever less likely that President Trump’s tax reforms will come to fruition. That sense of uncertainty appears to be leaving investors panicked.
Of course, this isn’t the first, nor will it be the last, time that political maneuvers have shaken investor confidence. Geopolitical events – like the death of a world leader, the breakout of a major conflict, or some natural disaster – will always have an effect on financial markets.
But to what extent should we be worried about it as long term investors?
When we take a look back at some of the world’s biggest events, the scope of their influence may surprise you.
On September 1st, 1939, Hitler’s army invaded Poland. It was, of course, on the front page of every major newspaper across the Western world. As it was Labor Day Weekend, the market did not reopen until Tuesday 5th.
So how did the stock market react to the outbreak of humankind’s biggest conflict? The Dow Jones went up 9.5%.
Fast forward to 1962, when the United States was locked in a potential apocalyptic stalemate with Russia over missiles in Cuba. At the height of the crisis, Russian and American ships were poised to clash, which would have turned this Cold War into a very hot one.
However, during this the same period (October 22nd – October 26th), the markets remained largely stable. Over the course of the week, the Dow fell less than 1% and then rose sharply as tensions dissipated.
A year later saw one of the most shocking events of the century – the assassination of John F. Kennedy. Again, rather than going into a catastrophic free fall, the markets actually rallied the following day and continued to do so for the remainder of the year -with the Dow finishing up 17%. It was a similar story with the assassinations of Robert Kennedy and Martin Luther King.
Are you starting to see the pattern?
In 2014, Sam Stovall of S&P Capital IQ conducted a study of how U.S. stocks have reacted to major global events (using the S&P 500 this time), and calculated how many days it took for the markets to recover.
Below are some notable findings:
- During the Cuban Missile Crisis, the market fell 2.7%. It took 5 days to recover.
- After the assassination of Kennedy, the market fell 2.8%. It took 2 days to recover.
- During the OPEC Oil Embargo of 1963, the market fell 1.9%. It took 10 days to recover.
- When President Reagan was shot in 1981, the market fell 1.2%. It took 4 days to recover.
- When Iraq invaded Kuwait, leading to the first Gulf War, the market fell 5.9%. It took 30 days to recover.
- Following the attacks of September 11th, 2001 – which were in effect a direct attack on the US financial system – the market fell 11.6%. It took 19 days to recover.
- Following the Madrid bombing in 2004, the market fell 4.1%. It took 18 days to recover.
Of course, there were instances when the market didn’t recover so quickly. The market fell 10.8% following the attacks on Pearl Harbour, for example, and took over 250 days for a full recovery.
However, other major downturns – like the collapse of Lehman Brothers and Black Monday – stemmed from deeper systemic problems in the financial system rather than singular political events.
But if you’ve been paying attention, you’ll have noticed that one major event, in particular, has been left out. This is the event that has been most closely linked to what is occurring in front of our very eyes – The Watergate Scandal and subsequent resignation of President Nixon.
Yes, the resignation of Nixon had a detrimental effect on stocks – from that day the market retreated 24.6% until it finally hit the bottom. However, it would be incorrect to lay all the blame on that one event. At the time, the US was already in the midst of a bear market, triggered by economic stagnation and an energy crisis that began the previous year.
We can see that markets, by and large, remain fairly agnostic when it comes to singular world events. Typically they experience a minor blip and then recover over the following days or weeks.
So considering we can’t predict these events, what can we do as investors?
Some would suggest that when turmoil like this strikes, we should get out of the market until it all calms down. However, that approach has actually been proven to harm your results.
In 2015, Bank of America Merrill Lynch conducted a study in which they back-tested two investment strategies going back all the way to the 1960s. The first strategy, the S&P 500 strategy, was to invest in the S&P 500 and hold it through thick and thin – a standard passive investing approach.
The other strategy, what they called the “panic selling strategy”, was to dump shares anytime the market fell more than 2% and reinvest after 20 days – as long as the market was flat or up in that period.
Below are the results:
As you can see, the buy and hold investors greatly outperformed the panic sellers.
So what alternatives are we left with?
We could try to time the market – a near impossible task. Or, we can approach investing with a stoic and disciplined approach that has been proven to work time and time again.
We can invest small amounts regularly, ignore the noise from Washington, and hold for the long term.
While we don’t know how the current situation will pan out, we know that throughout history, few things have been able to dent the market in the medium term, and absolutely nothing, has managed to halt its progress over the long term.