Lessons learned from prior foreign conflicts
TV Interviews with Erin Gibbs
Investors had two fears to grapple with last week, interest rates and the Ukrainian conflict. Potential for war or conflict has frequently sent markets on rapid downturns, regardless of the potential impact on the US economy. The nine months before the Iraq war, 6 of those where congress had granted direct US involvement, markets traded sideways right until President Bush started military action in March 2003. (see chart)
Recent wars and conflicts often have little to no impact on US company fundamentals (with the exception of a few defense and energy companies). However brief equity sell-offs still occur because of an emotional reaction to foreign conflict. In 2002 and 2003 there were small sell-offs, the longest lasting 4 weeks in August 2002, around North Korea’s multiple nuclear missile launches until reconciliation talks started at the Winter Olympics in Seoul.
The market reacted with similar dramatics in 2020, dropping -9.6% between Sept 3rd to Sept 23rd 2020 after US troops withdrew from Afghanistan. The withdrawal sent shocking images across media outlets. The S&P 500 traded sideways for most of the following month of October and then rocketed up 13.5% in just the last 2 months of 2020.
Events that have a big impact on emotions but little impact on economics can move markets sharply both up and down. If an investor does not want to ride out the short term sell off and recovery period they need to be skilled at timing both exits and reentries. It requires a stronger stomach at reentry points which can feel contrarian at the time. Recoveries are often at a faster pace than the downturn, so investors must be able to jump back in without full assurances or they risk losing out on the markets gains as it returns its focus to business and not war.
The good news around last week’s reaction was that not all markets behaved the same. It was not a complete equity sell off, the markets focused on high value growth companies. Value is only down -3.4% YTD, held up by Energy and Financials, while S&P 500 Growth is down -13.6%. Mid caps are only down -7.4% YTD versus -8.8% for the S&P 500 thanks largely to already compressed valuations. This year’s sell off is targeting the former darlings of the last two years and quickly bringing the broader markets back to favorable valuations.
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