Wars, Geopolitical Shocks, and Financial Markets

We examine how conflicts and geopolitical events influence financial markets, highlighting the impact on investor behavior and market volatility.

By Adam E. Day, Financial Advisor

Wars, Geopolitical Shocks, and Financial Markets

With recent events in the Middle East, how does the market tend to react in times of war and conflict?  The relationship between the stock market and war is paradoxical. While war is a human tragedy, history shows it is rarely a long-term bear case for the stock market. Markets are primarily driven by corporate earnings and economic growth, and while conflict introduces significant volatility, it often does not destroy the underlying value of major corporations. 

When we look back in history, when times of geopolitical events occur, markets usually have an initial drawdown period or shock effect.

This can be fueled by investor fears of the unknown, projections of higher input costs for companies such as oil or gas prices, or other more extreme examples of imperialistic takeover or nationalization of corporations, which has been much less common in the modern era.

Let's look at some of the major events that have transpired over the past century.

The chart above illustrates the 35 major events that have transpired since 1928, alongside the performance of the S&P 500 index over that same period. Showing the long-term resilience of financial markets.

Getting more granular with the data, let's look at how the market digested some of those events.

Source: First Trust, Ken French Data Library. Ken French data library uses the CRSP database. Past performance is no guarantee of future results. *Since the market was closed on 10/7/2023, 10/6/2023 was used for the event date returns. Universe includes all New York Stock Exchange (NYSE), American Stock Exchange (AMEX) & NASDAQ stocks. Returns are market-cap weighted. An investor cannot invest directly in an index. The information presented is not intended to constitute an investment recommendation for, or advice to, any specific person. By providing this information, First Trust is not undertaking to give advice in any fiduciary capacity within the meaning of ERISA, the Internal Revenue Code or any other regulatory framework. Financial professionals are responsible for evaluating investment risks independently and for exercising independent judgment in determining whether investments are appropriate for their clients.

Some key takeaways 

The average drawdown lasts about 36.5 days, with just over a -10% drawdown, and on average takes about 85 days to recover (see above table).

Trying to time the market is often a mistake investors make

During times of volatility, some investors may be tempted to withdraw from the market to avoid the bad days. However, by trying to sell out and subsequently buy back in, investors have to be ‘right’ twice. Often, the best performing days occur near the worst days and missing just a few of those good days can dramatically impact returns over time.

Take the long view

The concept of detachment can play a vital role in investors’ mental state during times of volatility. Detaching from the noise, investors can focus on their investment plan and how their risk is allocated.

A structured investment plan should be based on their current, intermediate-term, and longer-term needs; along with how the dollars within their portfolio relate to each one of these needs. We aim to accomplish this by having different layers of liquidity.

• Cash to cover and investors current needs.

• Fixed income intermediate term needs and approximately the next 3-5 years of cash flows.

• Equities to cover their long-term growth goals.

The volatility from market shocks usually occurs in the equity bucket. Therefore, a good investor takes a step back to ask the following questions and look back at their investment plan.

• How many dollars do I have allocated in both, cash and fixed income?

• How many years of cash flow needs can I cover with cash and fixed income?

• How much am I pulling from my portfolio annually?

• What is the likelihood that I would need to sell equities in the next three to five years?

• How long do these geopolitical shocks, on average, take to play out?

After working through these questions, if there is a misalignment, it might be time to connect and consult with your financial advisor to make sure that your life’s needs and plan are talking to each other.

Lastly, additional data tends to support taking a long-term view:

The chart above illustrates the probability of positive returns on the S&P 500 Index going back to 1937. It shows that in the shorter time horizon, the likelihood of a positive return starts at nearly 50% when you look at one trading day, and as you stretch to longer time horizons, the likelihood of a positive total return increases to a very high success rate on the five-year and ten-year timeframes.

For additional thoughts, please consult your Financial Advisor.

S&P 500 Index is a capitalization-weighted index calculated on a total return basis with dividends reinvested. The index includes 500 widely held U.S. market industrial, utility, transportation and financial companies.

Wells Fargo Advisors Financial Network did not assist in the preparation of this report, and its accuracy and completeness are not guaranteed. The opinions expressed in this report are those of the author(s) and are not necessarily those of Wells Fargo Advisors Financial Network or its affiliates. The material has been prepared or is distributed solely for information purposes and is not a solicitation or an offer to buy any security or instrument or to participate in any trading strategy. Additional information is available upon request.

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