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| Monday, August 18, 2014 | Issue #2355 | |
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How to Play the World's Geopolitical Crises Alexander Green, Chief Investment Strategist, The Oxford Club
 Pick up a newspaper or turn on the TV and it seems like the world is going up in flames.
The Syrian civil war has already claimed more than 100,000 lives. Boko Haram is terrorizing northeast Nigeria. The so-called Islamic State has seized enormous chunks of Iraq and Syria. Israel and Hamas are at each other's throats in Gaza. Anti-government rebels recently shot down a Malaysian passenger jet in Ukraine. And Russia - which already grabbed Crimea - is poised to create more havoc in that country.
As a global investor, how should you react to these unsettling events?
You shouldn't.
This is a considered answer, not a flip one. Let's take a dispassionate look at the history of the stock market...
Over the last hundred years, we have seen two world wars, several regional wars, dozens of civil wars and countless acts of terrorism. We have seen recessions, depressions, inflation, deflation, gold-backed currencies, fiat currencies, government ineptitude, deficit spending, political corruption and numerous business scandals.
Yet stock markets both here and abroad - with multiple interruptions (many of them jarring) - have always gone on to new highs. They remain near a high now. Why is this?
For one thing, the world today isn't in nearly as bad a shape as the national media makes it look. Capitalism, freedom and prosperity are growing around the world. Most people are living in peace. Despite the disturbing images on TV, the percentage of the world's population at war is at an all-time low. (If you doubt it, read Steven Pinker's The Better Angels of Our Nature: Why Violence Has Declined.)
The number of people who have died as a result of war and terrorism is down 50% from the 1990s. It is down 75% from the preceding five decades. The richest countries in the world are not fighting proxy wars or engaged in arms races.
Secondly, what ultimately determines where stocks go - both individually and collectively - is earnings.
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Look back at each of the thousands of publicly traded companies in the U.S. You will not find a single example of a company that increased its profits quarter after quarter, year after year, and the stock didn't tag along. Likewise, you will not find an example of a company whose earnings declined quarter after quarter that didn't see its share price drop, even in a rip-roaring bull market.
Yes, great companies can falter, and their weak sisters can rise, in the short term. But ultimately share prices follow earnings.
A Simple Formula
In his investment classic One Up On Wall Street, Peter Lynch - the world's greatest equity fund manager - wrote, "Despite nine recessions since WWII, the stock market's up 63-fold because earnings are up 54-fold. Earnings drive the market."
If you own a company that derives a significant portion of its sales or profits from Nigeria, Gaza, Syria, Iraq or Ukraine, its near-term prospects are almost certainly diminished.
But what firm is that? Sure, plenty of companies do some business in these areas or sell to other companies that do. But the overwhelming majority of U.S. companies have very little exposure to these areas.
So when people scratch their heads and say, "How can U.S. stocks hold up so well when there is so much violence in the world?"
The short answer is "First, there is less violence than you may imagine - and what violence there is shouldn't have much impact on corporate earnings."
Ergo, stocks don't crash.
This is not an argument that the bull market will continue, of course. Any number of things could derail the market, from weaker economic growth to future terrorist attacks to (most importantly) disappointing corporate profits.
But running your money based on scary images from conflicts overseas? That's emotion, not logic, so-called Big-Picture investing based on a blurry and uncertain outlook. And you shouldn't try this for one simple reason.
It doesn't work.
Good investing,
Alex | |
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