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CHAPEL HILL, N.C. — What were investors thinking as they propelled the stock market higher this week in the face of heightened geopolitical tensions?
The political news over the weekend was positively scary, after all. The headlines were heralding a new cold war, and Russia's most senior government media executive began bragging that his country could turn the U.S. into "radioactive dust."
Yet how did the stock market react on Monday? By soaring: The Dow Jones Industrial Average (.DJI) gained 182 points.
And, after Russia made it official by formally annexing Crimea — a news development that came before the market opened on Tuesday morning — the Dow rose even more.
Is the stock market nuts?
But at least in this case its reaction is in line with how it typically behaves in the wake of geopolitical crises.
Consider a comprehensive analysis of the impact on the market of non-economic events, which despite being nearly 20 years old remains one of the standard academic works on the subject. The article, which appeared in the Journal of Portfolio Management in 1989, was written by economics professors David Cutler and Lawrence Summers, both at Harvard, and MIT's James Poterba.
The professors designed their study to find evidence that non-economic news regularly has a big impact on stocks. They focused on all entries in the "Chronology of Important World Events" from the World Almanac for the period beginning with Pearl Harbor and ending with the 1987 Crash, and then eliminated from their list any events that the New York Times did not carry as a lead story and that the Times' Business Section did not report as having affected investors.
The result was a list of 49 distinct events, such as Pearl Harbor, the Korean War, Kennedy's assassination, and so forth. The professors then measured the average absolute return of the S&P 500 index (.SPX) on these days.
Yet, far from finding that non-economic news has a big impact, they found just the opposite.
On the days that news of these 49 events hit the stock market, the S&P 500 moved just 1.46% — less than one percentage point more than the 0.56% that prevailed on all other days. Because of this small difference, the professors concluded that there is "a surprisingly small effect of non-economic news" on the stock market.
This isn't to say that the market doesn't sometimes get spooked by geopolitical crises. But on those occasions when it does suffer, it typically recovers quite quickly. According to research conducted by Ned Davis Research, the stock market on average was 2.3% higher six months after the outbreak of the 28 biggest crises between 1940 and 1998.
Though the Ned Davis study was conducted before 9/11, the market's reaction to that crisis adhered to the historical pattern. Though the market did drop in that day's wake, by Oct. 26, 2001, the market was trading higher than where it closed on Sep. 10, 2001, the day before the terror attacks. That was just 45 days later.
The bottom line? Perhaps now is one of those times when the overall market knows more than we do.