Conflicts such as the Russian invasion of Ukraine don't tend to have long-term impacts on the stock market, which usually recoups after a few days.Vyacheslav Madiyevskyy/Reuters
War is spreading and the stock market is pushing record highs.
The day after Iran lobbed a barrage of missiles at Israel, opening up an alarming new phase in the Middle East conflict, the S&P 500 index closed to within a hair of its previous record high. Canadian stocks ended the day a few points away from setting their own high-water mark.
This may seem like an odd contradiction, or to some, an indictment of financial markets as indifferent to – or even benefitting from – disaster and tragedy.
But this is simply how the stock market is built.
Over a century of conflict, the stock market has demonstrated a near-immunity to geopolitics. From the Cuban Missile Crisis to Russia’s invasion of Ukraine, any negative reaction in stocks is typically recouped within days. Only when the global economy is threatened do these episodes tend to have any lasting financial impact.
Earlier this year, LPL Financial, a U.S. advisory firm, compiled a list of two dozen geopolitical flare-ups starting with the Japanese attack on Pearl Harbor in 1941.
The average move in the S&P 500 on the first trading day was a loss of 1.1 per cent. The index then typically sold off for 19 days, having cumulatively declined a modest 4.7 per cent. It took an average of 41 days in total for the market to make a full recovery.
The cold truth is that such attacks and regional wars tend to be non-economic events, at least on a global scale.
Consider the Sept. 11 terrorist attacks, when devastation was brought nearly to the steps of the New York Stock Exchange. Although that day had grave implications for global safety and security, U.S. stocks were back to pre-9/11 levels within a month.
Today, fears of a widening war in the Middle East are sending a jolt of volatility through financial markets. It’s a textbook kneejerk reaction – with Treasuries, the U.S. dollar, gold and oil being pushed higher, while stocks take a bit of a hit.
After Iran attacked Israel on Tuesday, the S&P 500 declined by close to 1 per cent – which is right in line with historical patterns.
In such moments, emotions tend to carry the day. When measured over years, however, the stock market hinges on economic fundamentals.
This is a phenomenon that can be measured empirically, in fact.
There are basically two avenues through which stocks can make gains. The first is the price-to-earnings multiple. When stocks whip around from one day to the next, it is largely a result of fluctuating valuations.
While little may have changed economically, the whims of investor sentiment can cause stocks to bounce all over place. These feelings are highly susceptible to the headlines of the day.
But for all of its drama, the stock market is a remarkably stable performer over long periods of time, with average returns coming in at about 9 per cent annually. These long-term gains are driven not by emotions, but by corporate earnings, which are closely linked to the broader economy.
Total returns in the S&P 500 over the past 20 years have been almost entirely driven by earnings, with a bit of a boost provided by dividend growth, according to a report published last February by Craig Basinger, chief market strategist at Purpose Investments.
“When you look at shorter periods, the importance of earnings growth fades, and the mood of the market dominates,” Mr. Basinger wrote.
These phases can span a matter of days, months, or even years. In 2022, when investor sentiment was crushed by runaway inflation and spiking interest rates, the S&P 500 fell by 19 per cent on the year, solely a result of declining stock market valuations.
In the days ahead, the potential toll in the stock market from the Middle East conflict will depend on how much the fighting escalates, and more importantly, how the war is filtered through the lens of investor sentiment.
But unless the conflict becomes a drag on global growth, rest assured, the stock market will ultimately look past the carnage.
There are lots of reasons to worry about this war. But your money probably isn’t one of them.