It’s rational to assume that negative developments like social unrest, violence, and wars would roil the markets, but that’s not necessarily how things have played out historically. To the degree that investors feel confidence in markets rising, and the profitability of certain sectors of the market, financial assets can weather more societal turbulence than we’d think. The real issue for markets, especially from already lofty valuations at the end of a lengthy expansionary cycle, are those two factors just mentioned – confidence and corporate profitability. It’s really not until those two things are disturbed enough that markets go down and stay down in a meaningful way. What causes the initial fractures in confidence and profitability could be any host of things, a bank failure, a reduction in lending, unemployment rising, a butterfly flapping its wings in Columbia, most of which are usually associated with a downswing in the broader economy, and if those fractures are large and persistent enough, then the inertia of market losses alone can be enough to further erode confidence and corporate profitability. Ultimately, it’s this self-sustaining feedback loop that’s responsible for the majority of bear market damage, much the same way the positive feedback loop is responsible for the majority of stock market gains as valuations are stretched to their limit in “good times”.
It’s possible that geopolitical events could provide an initial dent to confidence and profitability (more often the former, since conflict, unfortunately, can be profitable in the short term), but whether that would be enough to create the downward inertia necessary for big market problems, one never knows. What we’re more concerned about in the short term, as it relates to geopolitical risk specifically, is the potential for supply constraints and the subsequent shortages and rising prices that result from a breakdown in global cooperation and order. At the end of the day, these are the things that are truly important when it comes to sustaining the basic needs of life. A good bit more important than the level of the S&P 500.
Editor’s Note: This article was originally published in the September 2024 edition of our “Cadence Clips” newsletter.
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