How Do Markets React to Geopolitical Uncertainty?
We are living in challenging times. Economically, personally, spiritually—there have been no shortage of life-changing events impacting our lives over these last few years.
This past month is no exception with the tragic unfolding of the Russian invasion of Ukraine. It goes without saying that we are deeply saddened by this conflict and hope that a diplomatic resolution will be reached sooner rather than later.
Unfortunately, no one knows what the future will hold regarding this conflict and the impact it could have on our future both as Americans and as citizens of humanity. And also, of course, as investors.
Many investors are understandably looking for answers. Can a link be drawn between current events and market performance?
While no one can assuredly predict what will happen in the coming weeks or months, we can look at the market’s behavior over recent history to assess some potential outcomes.
Geopolitical Sell-Offs Are Typically Short-Lived
When we look back over geopolitical events of the past 60 years, we find that markets typically react negatively to the initial news in the form of sell-offs. Investors panic and flee to what they believe are safe havens—typically bonds, fixed income markets, and/or cash. We know this is not an atypical reaction to uncertainty of any kind and is similar during elections, natural disasters, and more.
However, as this Vanguard analysis illustrates (shown in the chart below), sell-offs are typically short-lived during geopolitical events and returns over the following 12-month period are largely in line with long-term average returns. On average, U.S. stocks had a 5% total return in the six months following an event and a 9% total return in the 12 months after an event.
The bottom line: Markets are forward looking and quick to overreact, but tend to stabilize relatively quickly.
Long-Term Possibilities
As Dimensional Fund Advisors explored in its timely piece, “Navigating Geopolitical Events”, ample historical precedent illustrates what can happen during times of political strife. Some markets may grow highly illiquid, or close altogether as severe sanctions and other influences impact trading. These types of market disruptions are not new, and the form that they take can vary.
It is important to note that the longer a conflict persists, the more stress it can potentially put on the market. Volatility will largely be a result of how much predictability investors perceive. In other words, when geopolitical developments become more predictable, markets adjust and become less volatile. But ongoing conflict can put businesses and markets under stress for an extended period of time.
Overall, the impact of geopolitical risk on the market can be hard to grasp as we cannot readily foresee what is to come. But the duration of volatility will be a reflection of how certain or uncertain investors feel about the events as they unfold.
The Road to Long-Term Wealth
Current world events and market volatility can be challenging to our investment discipline. Market news and commentary can often stir additional anxieties, making it even harder to maintain a long-term perspective. It is normal to feel emotional during times like this, and these emotions can occasionally impair financial decision making.
As we face an uncertain road ahead, please don’t hesitate to be in touch with any questions or comments you may have. We will always be here to guide you through these and other inevitable events as they pertain to your portfolio.
