Despite the stock market's strong rally two weeks ago, as the US began attacking Iraq, many market timers doubt that the beginning of the war meant the end of the bear market that began in 2000.
"News events rarely turn markets around," argued Michael Burke in the newsletter he edits, Investors Intelligence, "and reactions to news can be sharp but brief." In his view, the long-term market trend is likely to be down because "that was the direction of trading shown prior to this event."
The historical record, however, is not so clear cut. Building on an often-cited 1989 study that measured the one-day impact of big news events not directly related to the economy, I assessed the 12-month impact. I found that these events had no discernible effect on the stock market's trend, and that there was no way an investor could use this information to time the market.
The authors of the 1989 study were three economics professors -- James M. Poterba, David M. Cutler and Lawrence H. Summers. Summers would later become treasury secretary in the Clinton administration. He is now president of Harvard. Cutler is also at Harvard, and Poterba is at MIT.
To come up with their list of the biggest noneconomic news events, they relied on the World Almanac's chronology of important world events, from the Japanese attack on Pearl Harbor on Dec. 7, 1941, to the stock market crash on Oct. 19, 1987.
The professors excluded any event that the New York Times did not carry as a lead article and that its business pages did not report as having had an impact on markets. They were left with 49 events, including the North Korean invasion of South Korea in 1950, the Cuban missile crisis in 1962 and President Richard M. Nixon's resignation in 1974. If the professors updated their study to include March 2003, the start of the Iraq war would undoubtedly qualify.
For my extended study, I first eliminated big events that fell within a few days of one another. For the 36 events that remained, I compared the direction of the Dow Jones industrial average over the previous three, six and 12 months with its direction over the next three, six and 12 months.
Regardless of the length of the period, I found that about half the time, the stock market's direction did not change after momentous events. In other words, investors would have had an even chance of being correct had they always bet that the market would revert after a big event to the upward or downward trend that prevailed before it.
That finding alone, however, is not enough to conclude that momentous events have had no effect on the market's direction. After all, under more normal circumstances, maybe the market has a better-than-even chance of changing direction on any given day.
To find out if that has been the case, I checked the historical record back to 1896, when the Dow was created, to see how often the market's three-, six- and 12-month trends changed direction. They did so with virtually the same frequency as they did after the three dozen momentous events.
Finally, I checked whether there was any market pattern associated with an even narrower group of momentous days, those that were preceded by a declining market.
That situation, of course, is most analogous to today's.
I found that the market turned higher about three-fourths of the time on those occasions, though that probably can be explained by the market's historical tendency to go up more often than it goes down.
After every other 12-month period of declining stocks since 1896, the market turned higher with virtually the same frequency.
There is little evidence, then, of any enduring market pattern from the biggest geopolitical events. That means market timers should look for more justification than a quick end to the war before turning bullish.
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