The Callous Market

Friday Reflection | August 20, 2021

Looking at market news, you wouldn’t know that there is an unfolding crisis in Afghanistan, earthquake and storm induced devastation in Haiti, or wildfires burning around the globe. Financial headlines have instead been dominated by consternation over the Fed and whether they will taper their monthly bond purchase program sooner than anticipated. Broad equity markets declined this week by roughly 1%, but are still up almost 4% over the past month.

This week’s declines were not due to the tragic events in Afghanistan or Haiti even as these scenes weighed on our collective minds and hearts; rather, investors and market forecasters focused on the Fed and the possibility of slowing monetary support. This brings up the question: How can the market ignore these humanitarian crises?

History offers many examples of war and tragedy that can be used to analyze how markets make sense of the potential financial impacts during a crisis. These examples each had a very real human cost, but global equity markets prioritize a more analytical perspective that is biased towards wealthy countries in the process of determining stock prices. The key factors are whether the financial risks are short-term or long-term, and whether the crisis was expected or unexpected.

In Afghanistan, the implications for the global economy are unlikely to be disruptive in the short term. Despite the very real tragedy, the global economy is not imperiled by this conflict. The GDP of Afghanistan is $19.5 billion, which equals approximately 0.02% of the global GDP, or phrased differently would be approximately equal to nine hours of US GDP.¹ In 2020, foreign aid made up about 43% of Afghanistan’s GDP, down from 100% of it in 2009.² With no major global companies headquartered in the country, the market is predicting the impact to corporate earnings will be negligible, in the short term at least. The bottom line is that there is an inverse relationship between the areas of ongoing geopolitical risk and the areas of significant portfolio investments.
 
When a crisis does have wide-ranging short-term impact on the economy, the market has shown it will react dramatically. Shortly after the onset of World War I in 1914, the Dow Jones Index fell more than 30% because the war effectively ground the business world to a halt and market liquidity all but dried up. In a historic decision, the New York Stock Exchange closed for the remainder of that year.³ More recently, the broad US stock market fell by -33% in a little over a month as the economy went into lockdown last year and the Covid-19 pandemic began to surge. These events had material short-term economic implications for the global economy; the events in Afghanistan and Haiti do not have the same financial ramifications.

The long-term impacts of crises are much harder to quantify, and are therefore harder to price into the market. What will be the lasting impact of a destabilized Afghanistan? Will terrorism swell as a result, and what will be the cost of removing the economic contributions of millions of women and girls who will have restricted opportunity? What will be the cost in coming decades of increased natural disasters in more economically significant regions? The market tends to discount these far off risks to focus on short-term problems while maintaining a combination of ignorance and optimism toward the long-term. The market cannot effectively price in many larger and longer ranging problems: the risk of economic inequality, the burgeoning US debt, or the realities of climate change. This pricing inefficiency remains until some aspect of these problems emerges as a quantifiable near-term crisis.

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Despite the tragedies in Haiti and Afghanistan, and past wars and crises, the market has rewarded investors who stayed patient and kept an optimistic eye to the long-term in the darkest moments.
 
In 1915, when the New York Stock Exchange re-opened after being closed after the panic following the onset of the war, the Dow Jones Index rose more than 88%, which remains the highest annual return on record for the DJIA. In fact, from the start of the war in 1914 until the war ended in late 1918, the Dow was up more than 43% in total, or around 8.7% annually. In March of 1965, US troops were sent to Vietnam; the Dow Jones finished that year up almost 10%. By the time the last of the US troops were pulled out of Vietnam in 1973, the stock market had increased 43%, or just under 5% per year. The Cuban Missile Crisis had the world on the brink of nuclear war in October of 1962 when the U.S. faced a standoff with Russia. The confrontation lasted 13 days. In that two-week period, the Dow remained surprisingly calm, losing just 1.2%. For the remainder of that year, the Dow would gain more than 10%.

These examples aren’t meant to imply that war is good for markets; it isn’t. Rather, markets and investors understand that negative shocks (war, natural disasters, pandemics) will not last forever, and that initial price declines can represent opportunities to invest in quality companies that will endure and support our shared economy far beyond the end the of the current crisis. These investors are confident in our collective resiliency and ability to adapt to new circumstances. History has shown this to be a wise decision.

Stock markets may appear callous in not responding directly to humanitarian and environmental crises, but investors make investment calculations on a narrow range of information they deem relevant.  Still, our financial lives include more than just investments, and the global community can provide direct support to impacted regions at these catastrophic moments.
 
For the current Afghanistan crisis, that support can mean expanding refugee programs and evaluating commitments of foreign aid that will be the financial lifeblood of any new government in the country. For Haiti, and other regions impacted by natural disasters, it means sending aid, supplies, and resources as they rebuild. Beyond governmental support, many private and nonprofit organizations, as well as individuals, are providing financial and logistical resources to support the people in these regions. Global engagement and collaboration can go far beyond what markets can provide, and is essential to creating resolution to crisis, and positive change.

Resources

¹ GDP by Country. Population figures based on United Nations data. Worldometers.info
² Letters from an American – 8/18/2021. Heather Cox Richardson
³ This Day in History: Closure of NYSE During WWI History.com