Understanding Market Risks Through History

19 мар. 2022 г.

In this post, I'll be referring to the historical chart of the Dow Jones Industrial Average (DJI) in order to explain my perspective on risks associated with the market, and how to respond to current market conditions as a trader and investor.

This is not financial advice. This is for educational purposes only.

In my previous educational post, I discussed why the Fed's rate hikes were not as significant to us as we thought it'd be. I mentioned the idea of the market already pricing in not only the information itself, but also people's reactions to it as well. As announced, the Fed raised rates on the 16th of March, approving the first interest rate hike in more than three years. As anticipated in my investment thesis, the market handled this well, and the Nasdaq index alone has bounced over 10.49% since the lows of the past 5 days.

Today, I'm going to talk about the war in Ukraine from a statistical standpoint, and how this is unlikely to lead to a multi-year recession.

Historical Cases
- In 1914, the assassination of Archduke Ferdinand marked the beginning of the first global scale war modern society would witness
- The war lasted 4 years before Germany admitted its defeat and signed the armistice agreement.
- During this time, the Consumer Price Index (CPI) hit record highs of 110%, making today's 7% figures look moderate.
- After the war, the Dow Jones Industrial Average rallied a whopping 504%, before the American economy was struck with the Great Recession.

- After the Great Recession, the world faced a second world war in 1939, which started with Germany's invasion of Poland.
- The markets crashed, but not as severely as the Great Depression, and CPI recorded 74% during this period.
- With Japan's surrender, uncertainty was resolved, resulting in the DJI delivering 523% returns.

- Then came the Vietnam war in 1964, which started with the Gulf of Tonkin Resolution.
- The market ranged sideways for almost a decade, creating lower lows, with situations deteriorated by the Oil Shock of 1973.
- During this period, CPI hit record highs of 207% with factors of global uncertainty such as the war, which the US couldn't seem to win, and Oil Shock.
- After the war ended and the economy recovered from the Oil Shock, DJI delivered a whopping 1,447% returns, until the market started shaking again with the 911 terrorist attacks against the United States.

Lessons Learned
- So what is it that the market tells us?
- I've outlined what wars and regional conflicts do to markets in the post below:

- Historical cases tell us that the market prices in information about the war, and corrects in advance.
- Once the conflict actually takes place, the market starts to bounce from its local lows, as uncertainty has been resolved to an extent.
- From a macro perspective, as seen through the historical chart of the DJI, the end of wars usually mark the beginning of a multi-year bull rally as negative sentiment will have been completely cleared by then.

Market Risks
- That is not to say that I'm irresponsibly bullish. I do think there could be probable cases that lead to a global expansion of the crisis, and the collapse of the financial markets.
- For instance, Russia's use of weapons of mass destruction (WMD) could damage the markets to a greater extent than anticipated.
- It seems as though the market is considering this to be an improbable case, which it is, but there's no reason to be too complacent.
- According to an FSB whistleblower, it was recently revealed that Xi Jinping had plans to invade Taiwan this fall, depending on the success of Russia.
- If that were the case, then it wouldn't be a huge logical leap to consider north Korea's possible initiation of war against South Korea, and a war breaking out at a global scale.

Conclusion[/b
It all boils down to uncertainty in the market, and people's irrational responses to it. I believe that a successful negotiation between Russia and Ukraine could lead the markets to swiftly rebound once again, though that is not the only factor of uncertainty at the moment. Inflation (CPI) will eventually cool down in an organic manner, as markets realize the stability that is being brought to the economy, and the Fed's actual influence on the market.

People ignore bad news during uptrends, and they ignore good news during downtrends. I see a plethora of opportunities where companies that generate tremendous cash flow at an increasing rate with insane growth indicators, are neglected by the market. It's important that we clearly understand where we're at in terms of the market cycle. I believe that we're at a corrective phase of a bull market, rather than at the beginning of a recession. During corrections of bull markets, the smart move is to buy cheap stocks. It's worked effectively in making money 100 years ago, and I don't doubt that it'll work now as well.

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