- Investors often worry during geopolitical crises, and market commentators attempt to predict their outcomes.
- The history of American markets suggests that crises are typical during bull markets.
- Considering the inverse correlation between stocks and commodities over much of the last century, it is possible that crises are characteristic of stock market booms.
- If there is a time to worry, it is only after oil prices have spiked and when geopolitical crises take on a primarily anti-American tone.
- The current crop of crises do not appear to pose immediate threats to the market.
A week or so ago now, Jean-Marie Le Pen, the founder of the resurgent National Front, delighted in what he seemed to regard as a clever pun about the Holocaust. I am not enough of an expert on Marshall Petain or Le Pen to describe the latter as a Petainist, but that is the strand of French history that Le Pen is most commonly associated with.
The rise of the right in Europe and the routing of the Iraqi army in Mosul, I suppose, reminded me of one of the most interesting charts I have ever come across. In the late Barton Biggs's book, Wealth, War & Wisdom, he shows (see Figures 10.1 and 10.2 in that book) that, in real terms, the French stock market tripled between mid-1939 (roughly, the carving up of Poland and the beginning of the "phony war") and the end of 1942, well after the Third Republic had been replaced by the Third Reich. In nominal terms, the jump was about 600%.
Obviously, that raises a lot of questions about what was going on in France at that time, but even assuming, as Biggs seems to argue, that a good portion of the French middle and upper classes were thrilled with French defeat, it is still amazing (to me, at any rate) that, as investors, they could have been quite so sanguine about war, whatever the outcome.
The lesson I take from this is that it is very hard to predict how markets will respond to political events, assuming that "how markets respond to political events" is the correct way to frame the issue in the first place, and not "how politics respond to market events."
In the following sections, we will briefly run through how foreign affairs looked during the most considerable bull markets (NYSEARCA:SPY) of the last century or so.
1980s and 1990s
In a number of previous articles, but most recently in an April article comparing the present market to the 1920s, I have argued that crises abroad are typical during bull markets. The present market, of course, has seen upheavals of various sorts especially around the Mediterranean, Black, and South and East China Seas. During the late 1990s bull market, we had the emerging markets crisis, but before that, we had the fall of the Warsaw Pact, the Balkan wars, Tiananmen Square, and the collapse of the Japanese "bubble."
The deflationary scare of the late 1990s and recent years now seems to have been part of a much larger disinflationary downdraft decades in the making. Japanese inflation had been falling (relative to US inflation) and the yen rising from the mid-1970s. During the steepest decline in commodity prices in the late 1990s, North Korea, Ethiopia, and the Congo experienced famines, each generally in the context of war and confrontation. Depending, I suppose, on how one imagines what the relationship between supply and demand ought to be, it is curious how many famines have occurred during the worst collapses in commodity prices and financial markets, especially to economies furthest removed from the capitalist world. Ethiopia has experienced famines in the mid-1980s, late 1990s, and 2009, all periods of sharply reduced commodity prices.
Throughout the 1980s, the Soviet Union was engaged in war with the mujahidin, and Iraq and Iran were locked in a vicious war with one another. Syria, too, had a civil war in the early 1980s while Israel chased the PLO around Lebanon, soon after which the US and France lost nearly 300 servicemen in the Beirut bombings by Hizbullah. The New Yorker referred to this recently as "Reagan's Benghazi."
Iraq's invasion of Kuwait seems to have been incubated in the belief that the fall in the price of oil was being orchestrated by ungrateful Arab neighbors with the tacit approval of the US. Saddam seemed to have regarded the emirate as his prize for having wrestled Iranian revolutionary fervor to the ground.
The deflation that we associate with the Depression began in the early 1920s, as did the political problems that we tend to associate with the Depression. Hitler staged his beer hall putsch in Munich during a period of infamous hyperinflation, but that seems to have been a relatively brief period coinciding largely with the recovery in global prices after the severe 1921 recession, in much the same way that the Arab Spring seemed to be in response to the 2011 spike in commodity prices after the crisis in 2008-2009. Recall that the Spring began with self-immolation by an unemployed man who was allegedly humiliated by Tunisian police for selling vegetables illegally.
After the crisis of 1921, as well as the bombing of Wall Street in 1920, the 1920s roared in the US but they were chaotic abroad. Hitler's putsch is emblematic in hindsight, but that was but one event in a string of crises in post-war Germany. Elsewhere, Mussolini's Fascists were already in power by 1922, also the year in which Ataturk deposed the last of the Ottoman sultans. In the Soviet Union, after the civil war at the beginning of the decade, the famine of 1921, and Lenin's death in 1924, the split between the more nationalist Stalinists and the internationalist Trotskyites broke out into the open. A similar sort of split occurred in China, when, after the death of Sun Yat-sen, Chiang Kai-Shek turned on the Communist Party, almost wiping it out. Parts of China in the late 1920s also experienced famine, as did Rwanda and Burundi. As with much of the rest of the world, Japan was in the throes of an anti-Communist reaction in the late 1920s.
1927 was also the year of the greatest school massacre in US history, when a farmer conducted a series of attacks reminiscent of the Anders Breivik mass murder three years ago in Norway.
If we turn to the boom at the beginning of the previous century, the long slump in consumer and commodity prices had ended in the mid-1890s, but during the biggest jumps in stock prices in the subsequent boom, as in 1900-1901, deflation was the rule.
As for economic conditions abroad, according to Wesley Mitchell's Business Cycles, Europe experienced a depression from 1901-1904 after a crisis in 1900. But, "in the United States this crisis was represented by nothing more than a brief pause in a period of exceptional prosperity….Corn exports were reduced by the short crop, iron and steel exports by the depression in Europe, and copper exports by the depression and by high prices. So strong was the business situation, however, that none of these depressing influences had more than momentary effect." This was also a period of technological revolution (e.g., automobiles, electricity, chemistry) and perhaps the beginning of our anxiety about the nature and pace of technological change.
Off the top of my head, I can think of a few political crises from that period, as well: the Boer War (seen as an indicator of England's grip on her empire), the Russian occupation of Manchuria, the aftermath of the brief Spanish-American War, the anti-Western Boxer Rebellion and the Allied Expedition to suppress it, and a spate of anarchist assassinations, including that of President McKinley. More broadly, in Europe, hopes that Germany and England could be reconciled died with Queen Victoria while the multi-ethnic empires of Eastern Europe struggled with the rise of nationalist awakenings and the growth of the West. In Asia, the trajectory of developments in China and Japan seem to have required the vicious war that would come on the continent. Japan was between historic victories over China and Russia.
Finally, we can consider the middle decades of the last century. In some ways, this is the most difficult period to examine, because it is not altogether clear if the period between the Great Depression and the Great Stagflation should be considered one extended boom or a series of separate booms. Mid-1932 to early 1933 was perhaps one of the best times in the history of the market to buy in (for virtually any holding period), but early 1937 was one of the worst times ever to buy into the market. Buying into the market anytime between 1938 and 1954 was also profitable, although the absolute best time to buy in would have been in April 1942, which as Biggs pointed out, was the time of the decisive Pacific battles, and you would not wanted to have stayed in the market beyond 1968.
The point is, however, whether you want to count the beginning of the secular bull market from 1932 or 1942, and conclude it in 1965 or 1968, these periods experienced terrible crises abroad, which hardly need my recounting. For the purposes of comparing bull markets and foreign troubles, however, we might do well to focus on the 1950s, when the S&P 500 experienced a phenomenal boom, despite all sorts of commotion overseas: the Korean War, the establishment of the Warsaw Pact, the Suez Crisis, the Anti-Rightist Campaign in China, the Great Leap Forward and the subsequent famine, a terrorist attack in Congress, Dien Bien Phu, the Algerian War of Independence, Soviet nuclear tests and the Rosenberg Trial, American intervention in Lebanon, the Cuban Revolution, the Chinese invasion of Tibet, two "Taiwan Crises" and the sacking of the embassy in Taipei, the Hungarian Revolution, the East German uprising, McCarthyism, the coups d'etat in Egypt, Iraq, and Iran, the unifications of Egypt and Syria (the United Arab Republic) and of Iraq and Jordan (the Arab Federation), the Malayan Emergency, famine in Ethiopia, the Mau-Mau Rebellion, the collapse of Belgian rule of the Congo, and a number of deadly incidents involving the US and the USSR.
In short, it does not appear to me that there is a straightforward connection between American stock market performance and foreign upheaval.
What about oil crises, though?
Stephen Leeb has already demonstrated that it is generally safe to wait until after an oil shock has hit before withdrawing from the market. It would appear that there is little need for equity investors to anticipate oil prices or crises, only to monitor them.
If one does want to be able to predict oil shocks, however, there are usually already signals in the market. Most recessions have been preceded by oil shocks, but they have also been preceded by flattened yield curves. Before an oil crisis, a squeezing of the yield curve spread typically occurs, gold may jump, or oil may have recently experienced a sudden drop. None of those things have happened in this market.
In conclusion, it is often said that commodity prices are "safe havens" for investors during periods of equity trouble. Actually, I think the connection is between commodity prices and the P/E ratio (or more properly, the earnings yield). In any case, if one is apt to take either of those two claims seriously, it would suggest that there is some sort of connection between equity prices and world commodity prices. But, that would suggest that a rich man's boom is a poor man's bust. If there is a substantive connection between American equities and commodity prices, it would not be hard to imagine that the downward pressure that commodities feel during stock market booms would exacerbate structural weaknesses in societies geared primarily towards the primary and secondary sectors of the global economy.
One might expect stock market booms, therefore, to coincide with greater degrees of chaos in the Global East and South. I suspect, therefore, that we will see not only more but more severe crises over the next 24-36 months. As long as these crises are not predominantly anti-American (e.g., the anti-War movement in the 1960s and '70s, the Oil Embargo, the Iranian Revolution, 9/11), investors should see them as consonant with a bullish market today, although they may be more problematic once the boom ends.