Cai Jin

The carpe diem principle of stock market investing

History shows that share prices are rarely rattled in a major way by political crises

It is customary to find traders speculating about the possible impact that nasty surprises on the political front could have on the stock market. Yet if you look closely, you will find that share prices are rarely rattled in a big way by political crises.

Take the recent upheaval: North Korean dictator Kim Jong Un firing missiles over Japan, threatening to bomb United States territories and testing hydrogen bombs.

Even the markets closest to North Korea - Seoul and Tokyo - were hardly ruffled by the escalating war of words between Mr Kim and US President Donald Trump.

In fact, the Financial Times observed in a recent article that the Kospi - the market barometer for South Korean stocks - is actually positively correlated with the North Korean missile tests.

"It is hard to say that (the tests) have even affected the country that stands to be most directly damaged by a war starting on the Korean peninsula," the newspaper added.

It shows that despite the media hype over the missile tests, there is no imminent danger of World War III, and stock markets know it.

Tragic though wars of any size may be, such conflicts rarely affect the world economy in a way that would disrupt commerce globally. Despite the series of North Korean missile tests, ordinary South Koreans and Japanese are going about their everyday lives normally.

Sabre-rattling seldom overpowers the world of commerce and finance. It can cause share prices to gyrate, but that usually ends very fast. For savvy traders, it is often a case of "sell on the rumour, buy on the news".
Sabre-rattling seldom overpowers the world of commerce and finance. It can cause share prices to gyrate, but that usually ends very fast. For savvy traders, it is often a case of "sell on the rumour, buy on the news". PHOTO: AGENCE FRANCE-PRESSE

The only exceptions I can think of are wars on a global scale.

One example would be the outbreak of World War I, when stock exchanges in Europe were forced to close and shops stopped accepting paper money for purchases. The panic was so great that in some European countries, only gold would do as payment even for basic foodstuffs.

In 1938, tensions leading up to World War II cut short a rebound from a credit crisis triggered by the US central bank tightening liquidity too early as its economy recovered from the Great Depression. Stocks sank until 1942.

Those two occasions aside, sabre-rattling seldom overpowers the world of commerce and finance. It can cause share prices to gyrate, but that usually ends very fast. For savvy traders, it is often a case of "sell on the rumour, buy on the news".

As investors, our role is to start thinking about how we can play such negative developments to our advantage. The next time you see markets tanking in response to a bad news item, the best thing you can do is to buy on the dip.

Recent history is replete with such examples. When the Korean War started in 1950, Wall Street plunged by 14 per cent but it rebounded very fast and rose about 26 per cent over the length of the conflict.

Similarly, stock prices fell in the run-up to the Six-Day War between Israel and Arab states in 1967, but rose every day during the combat.

Stock prices across the globe plummeted when Iraqi tanks rolled into oil-rich Kuwait in August 1990, but rose when fighting by US-led forces to liberate Kuwait started four months later.

History repeated itself during the 2003 invasion of Iraq. World stocks dipped briefly as the dispute escalated, then started soaring after fighting began. The rally carried on until the end of the year.

Similarly, there was a massive knee-jerk sell-off in September 2001, following the terrorist attacks in the US, but , within weeks, markets had recovered their poise.

One reason markets rarely get rattled on bad news on the geopolitical front is that they are efficient enough to estimate the probability of war breaking out and whether this will trigger sufficient chaos to wreck the world's financial system.

As it is, if war was imminent on the Korean peninsula, Seoul would have been in a panic and the Kospi would have plunged dramatically. But the South Korean stock market is one of this year's best performers, with a gain of more than 20 per cent.

The same observation can be made of political crises of different stripes.

Take the hysteria over Brexit - the referendum in Britain last year to decide whether it should stay in the European Union. When it was announced that British voters wanted "out", New York and London were not open for trading - but stock prices in Tokyo plunged 7.2 per cent, even though the news had nothing to do with the Japanese market.

The subsequent sharp rebound only served to further confirm the observation about the short-term influence that such events have on the market.

Who now can also recall the soap opera, starring various heavily indebted European nations, that used to get a regular airing every summer during the European debt crisis? It was a drama that ran between 2010 and 2013, filled with riveting twists and turns - Greek sovereign debt, Irish banks, Portuguese debt, Italian debt, Spanish banks, more Greek debt and the Cyprus crisis - and even the grand finale of a possible break-up of the euro zone itself.

Yet investors who made wagers on European blue chips with strong business franchises and good cash flow would have been richly rewarded for their perseverance during this period.

We now live in a world where information flow is almost instantaneous. This can cause social media to generate a lot of heat and light, but it rarely influences the market in a significant way over a sizeable stretch of time. Instead, within a couple of days, and often within a matter of hours, the media would have moved on to the next "crisis" and most of us would have completely forgotten what everyone was so upset about.

As investors, our role is to start thinking about how we can play such negative developments to our advantage. The next time you see markets tanking in response to a bad news item, the best thing you can do is to buy on the dip.

Share prices will usually bounce back very quickly. What you must do is ignore the noise; there is usually some profit to be made as long as you can tune out the hysteria.

•Goh Eng Yeow will be launching a new book, Market Smart, on Friday.

A version of this article appeared in the print edition of The Straits Times on October 02, 2017, with the headline 'The carpe diem principle of stock market investing'. Print Edition | Subscribe