Panic may once again be a poor guide right now

Geopolitics is once again taking center stage in the financial markets. Since the American and Israeli attack on Iran, investors’ nerves have been on edge and volatility has surged. In moments of panic, investors risk making the wrong decisions. Let that be the first lesson: keeping emotions under control is crucial in this market environment.

Lesson two is to take a look back at history. Do geopolitical events cause lasting damage to the stock markets? The answer is no. Graph 1 shows the performance of the U.S. S&P 500 index, the index of the 500 largest American companies and one of the most important stock indices in the world, twelve months after a major geopolitical event occurred.

What do we see? On average, the S&P 500 delivers a positive return of 14.2 percent. This is an important indicator not to sell blindly when markets are in turmoil due to political tensions.

Graph 1

Source: The Compound Research

The current crisis surrounding Iran has an additional dimension. Iran is an important oil producer and controls the Strait of Hormuz. Along this maritime route, numerous ships loaded with oil and natural gas sail every day toward energy hungry countries such as China. Due to the current crisis, this shipping traffic, an economic lifeline for the global economy, has virtually come to a standstill. As a result, oil prices have risen sharply.

Will this higher oil price cause economic pain that could send the stock market tumbling?

Graph 2 clearly answers this question in the negative. What does the chart show? The red dots represent two consecutive days during which the oil price rises by at least 5 percent. The conclusion is clear. Every time this occurred, the S&P 500 stood about 22 percent higher twelve months later. Once again, this is a reason not to immediately give in to panic.

Graph 2

Source: The Compound Research

Conclusion

Geopolitical events always create nervousness and volatility in the stock markets. However, the charts above show that reacting impulsively and emotionally, for example by quickly selling stocks, is not the most appropriate strategy. Twelve months after geopolitical events or sharp increases in oil prices, the U.S. S&P 500 index, which still sets the tone for other stock markets, often stands higher.

That is why it seems advisable to accept short term volatility in order to realize the potential higher long term returns that investing in equities can offer.