Investors today are facing both rising stock markets and elevated uncertainties due to geopolitical events and upcoming elections. Backed by decades of data, we observe that such market impacts are historically transitory, and believe “time in the market” is better than “timing the market.”
Markets are uncertain
Financial markets are characterized by their dynamic and complex nature, often following a different path from that forecasted. In an environment of heightened uncertainties, we explore the following concerns:
- Investing when markets are close to historical highs
- The impact of geopolitical tensions
- US election year uncertainties
Investing after a rally
Over the long-term, equity markets tend to trend upwards, and investing in equities can potentially provide long-term growth to portfolios. Following substantial rallies, however, the psychology of getting and even staying invested can prove to be challenging.
Market impact of geopolitics
Geopolitical tensions can be associated with negative events such as supply shocks, trade disruptions and economic instability. It is understandable therefore that these cause concern.
With reference to the selected recent geopolitical events in the previous chart, following some initial volatility, historical developed equity returns (as measured by the MSCI World Index) were mostly positive after one year.
A notable exception was the 1973 Oil Embargo, following which developed equities saw significant downside. However, unlike the 1970s when OPEC accounted for 50.3% of global crude oil supply, production is now diversified across OPEC (36% of production), the Organization for Economic Co-operation and Development (OECD) (31%) and other countries (32%)2 thereby potentially muting any future economic impacts.
2 Source: Bloomberg, BP Statistical Review. Data as of 31 Dec 2022, for OPEC/ OECD Crude Oil Production. Due to rounding, figures may not add up.
US election uncertainty
Elections often introduce uncertainty over future fiscal and monetary policies, as well as foreign policies and trade. This unpredictability around potential impacts make elections closely-watched events.
Historically heading into a US presidential election, US equities saw heightened volatility, especially when a change in political party was upcoming. And on average, the S&P 500 index delivered a stronger average post-election rally when the incumbent party won. However, average US equity market returns a year after US presidential elections were historically positive no matter the result.
Short-term volatility is normal
Movements in markets are normally measured via volatility, which quantifies movements in asset prices, with greater movements being reflected in higher volatility. Much as stock prices can be charted with equity indices, the VIX index shows the levels of volatility of the S&P 500 index.
While higher volatility often correlates with market corrections, we see that spikes in volatility tend to be transient, while markets have grown over time.
Staying the course
It’s impossible to predict when drawdowns will happen, but the recoveries that follow can be studied. We see this on a global scale as well by observing below the months to recovery for the MSCI World global equity index3 following drawdowns of differing extents.
We see that the time to recovery — i.e., to return to the same level as before the drawdown — is only 2.7 months for drawdowns of -5% to -10%. Moreover, even for strong drawdowns of up to -40%, global equities took on average only 14 months to return to their previous levels. This speed of recovery argues against timing the market, as investors would need to be right in both the timing of exits and reinvestments, repeatedly over time.
There were three severe historical drawdowns in the last 50 years of over 40% falls. These were the 1973 Oil Embargo, 2000 Dot-com Bubble and 2008 Global Financial Crisis. In these cases, global equities took an average of 57 months to recover to their prior levels.
3 Global equities include both US and non-US equities.
Staying in cash has a cost
One way to help mitigate all market turbulence is to have a large allocation to cash. However, while an investment in cash does help reduce exposure to market price movements, it may also add inflation risk. Inflation can erode the purchasing power of cash as more money is required to buy the same goods and services.
For example, US$100 in 2000 would only have been worth US$81.50 at the end of April 2024.
Overall, we believe investors should take suitability and objectives into consideration. Despite the inflation risk of holding cash, investors with a shorter time horizon and lower risk tolerance should generally have higher allocation to cash and to lower risk assets such as fixed income.
Key take aways
In an environment of uncertainty, staying invested has historically been a successful strategy. We have shown:
- Investing in global equities during a rally historically generated positive returns on average over the following year.
- The equity market impact of certain geopolitical events was historically short-lived.
- Greater geographical diversification of oil production compared to the 1970s has reduced the likely impact of oil supply disruption on equity markets.
- In US presidential election years, US equities historically performed better on average over the following 12 months when the incumbent party won. However, US equities were higher on average 12 months after the election no matter which party won.
- “Time in the market” can be more beneficial than “timing the market.” Following bear market drawdowns of up to -40%, global equities on average took only slightly more than a year to recover. Beyond -40%, as has happened three times in the last 50 years, the drawdowns could take nearly five years on average to recover, and investors should be aware of this risk.
- Holding cash to avoid being invested through uncertainty itself has a cost. Inflation can erode purchasing power over time. Staying invested can offer the opportunity for a portfolio to grow in excess of inflation.
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