Last week’s plane crash reinforced the notion that the world can be at times a dangerous place. A plane crash is always tragic, given the large loss of lives, but to have a passenger plane shot down by a missile adds an extra degree of horror. Prior to this event the broad based S&P 500 had not had a daily move of more than 1 percent in three months. This was the longest stretch of market calm we had seen in nearly 20 years. Interestingly the market regained most of what it lost the next day.
The two day market action might lead someone to conclude that the initial market drop was an over reaction. People have learned that markets do come back after negative events; however, recovery from some other events has taken months or even years.
Had this been an American airliner shot down, the market reaction most likely would have been more severe. In addition, other than the normal rhetoric exchanged among world leaders, there did not appear to be a major escalation of tensions after this incident.
What needs to be determined is whether this incident leads to more significant sanctions against Russia. Russia is a major energy producer, and much of Western Europe is dependent upon its natural gas. Given this dependency, it is questionable whether more meaningful sanctions will take place.
This dynamic explains why the stock market reaction has not been too severe thus far given the events in Ukraine. For now the expectation is that there will be little disruption to the global economy.
I have on a number of occasions mentioned that investors need to have a long term focus, and not panic on near term events. It appears that investors by and large did not panic on the news of this plane crash.
However, investors must realize that in the future there will be other incidents. Some of these may result in the market dropping 5 or even 10 percent in a matter of days; unlike the 1 percent drop we had the day of the plane crash.
The very low volatility we have experienced in recent months is not the market norm, but neither is the extreme volatility of 2008. When markets have been calm some investors may become complacent and take on additional risk. However, that is not an appropriate strategy, since markets will eventually become more volatile.
The downed aircraft should reinforce the notion that global events can influence the stock market. In addition Ukraine is not the only area of the world with conflict, as we can see the continued tension in Gaza between Israel and the Palestinians.
It is important that investors have a reasonable approach to risk. Someone may not want to own stocks because they are afraid of losing money. However, if you have all your money in a savings account, you are losing money to inflation, since savings accounts currently pay virtually no interest.
Investors must realize that there will be international incidents that will disrupt the stock market from time to time. Some will be more significant versus others. Still, someone needs to keep a long-term perspective and recognize that markets will eventually recover from negative events.
Likewise investors should realize that after a period of relative market calm eventually something will happen to disrupt the stock market. That is why it is important not to invest in risky assets, if you have a short-term investment horizon. Therefore, when markets are calm and have been strong, it is a good time to reduce your stock holdings, if they have grown beyond your targeted percentage.
Allen Wisniewski has been involved in finance for more than two decades. He lives in Culver City with his family.