If the Sky is Falling, Where Will it Land?

In the last three weeks, the U.S. stock market has lost almost 5% of its value though there was a recovery on Friday. This coincides with presidential sabre rattling over trade with China and presidential bad mouthing of Federal Reserve Board interest rate policies.

Cue Chicken Little. Is the sky really falling and, if so, where will it land?

A logical question might be “which sky?” but nobody is much interested in logical questions when it comes to either the President or the stock market.

Let’s have a short think about the impact of geopolitical events on the stock market.

I have intentionally omitted the 2007-2008 mortgage meltdown because it was a financial rather than geopolitical event. Of course that did not reduce the unpleasantness.

The other day I happened on a chart provided by an investment management firm. It was quite interesting and I’d be happy to give them credit for it (which they would probably like to have), but naming the firm and discussing the chart in detail would trigger the worst words in finance: “let’s run it by compliance.”

Here we go: non-detailed, non-credited, but much appreciated.

The chart looked at the impact of geopolitical events (do trade wars with China come to mind?) on stock market outcomes over a week, a month, a quarter and a year. Thirty-two events that have happened since June 1972 (Watergate) were listed.

If you are concerned about a week, a month or even a quarter, you should be ashamed of yourself. Oh, how often I wanted to say that when I was in that business. Feels good to say it now though.

A year after each of the 32 events, the market was still down for eight of them. The worst was the Yom Kippur war in 1973 when it was off by more than 43%. Some readers will remember the 1973 recession, which likely had a greater impact on the stock market than did the war.

The USS Cole bombing (October 2000) overlapped with the disputed Bush Gore election (November 2000) and the score for both events one year later was down around 20% but it was the same 20% for both since they happened one month apart. Does anyone remember the dot com bubble bursting at the same time? Seems like that was the more important factor in the stock market decline.

September 11 and the War in Afghanistan (both 2001) also left the market in negative territory a year later (15% and 25%, respectively) but the dot com bust was continuing.

In 24 of the 32 cases, the market was up a year after frightening external events, sometimes way up. For example, a year after the Atlanta Olympic bombing in 1996, the market was up over 50%. The first and second Gulf wars led to one-year gains of 36% and 29%. Even Brexit left the market almost 18% higher one year later. On average, the market gains nearly 9% one year after a geopolitical event. That is only slightly below the average for all years.

Without getting all “mathy,” the stock market’s response to geopolitical events is pretty random. Other factors are far more important.

Fun fact to ponder: divide the five decades since Watergate into one three-decade period at the beginning and a two-decade period at the end. In the three decades to 2001, there were 18 geopolitical events. A year later, the market was down for eight and up for 10. How about the most recent two decades? A year later, the market was up 14 times out of 14. Is it reasonable to ask if policymakers are getting better at this?

How about some other skies that might be falling?

Could the trade war push the economy into recession? Damn right it could, which is one of the reasons using trade to placate displaced workers is a dumb idea. Yes, even if the displaced workers are your voter base. Hurting farmers with trade wars does nothing for displaced manufacturing workers. Pretending to stand up for blue-collar voters might get some votes in the near term but those votes come with significant resentment if a recession ensues.

Why then does the President play the tariff card? Because he can do so without any other approval. There are no checks and balances on this one.

Now for something that does matter. Unless you are on a Manhattan commuter train, you will not find more than one person in 1000 who can explain the dreaded inverted yield curve. We have one now and they often but not always predict upcoming-but-not-always-immediate recessions. While less then totally accurate, inverted yield curves are not a good sign.

Is a recession going to happen anyway? Well, we are certainly due for one. The heavily stimulated economic expansion since the mortgage meltdown is one of the longest on record. Of course we are all greedy and want to see it continue, but eventually it will end and there will be a recession and that will be followed by another expansion as the inevitable cycle continues.

Well then, whose sky might be falling?

According to betting markets, the President’s chances of winning reelection are now about 50-50. A recession in the coming year would lower his odds sharply. In the 18 elections since World War I where an incumbent ran for a second term, those who faced a final year recession lost five of six, while those who did not won 12 out of 12.  This goes a long way to explaining President Trump’s outraged tweets at Fed Chair Jay Powell.

A bear market in the coming year is not as bad for the President as a recession but it is certainly not good. The stock market during the Trump administration was up 40% before the recent downturn. That is better than any other recent President’s record but don’t get me started on Presidents causing bull markets. They don’t. Nonetheless presidents do benefit from them.

Imagine another 15% market decline before the election. That would still leave the “Trump Market” in the middle third of recent presidents. But what will voters think about?

Remember this line from earlier in the story?

“If you are concerned about a week, a month or even a quarter, you should be ashamed of yourself.”

I didn’t write it because I wanted to, I wrote it because I had to.

Voters will think about the recent past and blame the President. Then where does he aim his tweets?

If the sky is falling somewhere, it is more likely over 1600 Pennsylvania Avenue than over your house.

2 Responses to “If the Sky is Falling, Where Will it Land?”

GARRARD GLENN, August 16, 2019 at 10:02 pm said:

Tarnation! The stock market goes down, as well as up!

Maybe it’s better to buy a liquor store than invest in the stock market.
Liquor stores always make money. Maybe more in bear markets. Sorrows need drowning.

Nice fact: the stock market always comes back after even profund drops.

But, it can take a lot of time to do that. In the last century, if you invested a dollar in 1929 in the market, it took until 1946 for the market to return that dollar. As they say, sometimes it’s more important to pay attention to the return of your money than the return on your money. Then from 1969 to 1982 the same thing happened: you got the dollar back you invested in 1969 in 1982.

So, a lot of investment firms start segueing their clients into bonds after the age of 50 or so. The Pimco Total Return bond fund has returned 7.21% per year since its inception in 2009. The most it dropped was 1.92% in 2013. Some people sleep a little better with 1.92% drops as opposed to 58% market drops and the like. But how will the fund do in the next 10 years? Will it beat or match the stock market, which returns on average about 8% a year, for over a hundred years?

Stay tuned. Or buy a shabby old liquor store, polish it up, and wait for the next bear. You’ll likely do quite well in a bear, and that’s a lot easier than shorting the market.

Reply

Ron Bogdasarian, August 21, 2019 at 2:21 am said:

I’d be most willing to have, even invite, a properly timed recession that would turn over the White House to anyone other than the current resident. Republican opponent Bill Weld was Harvard ‘66

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