Summary: You can’t blame pandemic-fatigued investors for being scared when we learned there was a coup underway in Russia. Whatever the result turns out to be, geopolitical earthquakes like this one can trigger a tsunami of aftershocks. When they do, and markets react emotionally, remember that scared investors make bad decisions. The best strategy is not to be one of those scared investors. This is a time to remain calm and take advantage of opportunities created by the overreaction of others.
There have been times in history when investors had reason to be more anxious than today, but not very many of them. Hard on the heels of a global pandemic, we find ourselves in a world that is increasingly run at the whim of autocrats, Russia has invaded Ukraine and threatens nuclear madness. The US and China are fast moving fast toward a new Cold War, and Xi Jinping makes weekly threats to take Taiwan by military force, which would shut off 80% of the world’s supply of cutting edge semiconductors.
And then we woke up on Saturday to learn that Putin’s pet chef/mercenary had turned on his master and was attempting a coup. I’m not going to try to explain what happened here; the facts will all have changed by the time the market opens on Monday anyway. In this post I want to discuss how we should react to it.
Calmly. And we need to hold that pose because there are going to be a lot more weekends like this one before things settle down.
As my friends in Japan know, major earthquakes don’t come by one’s. (Japan sits atop a movable earthquake feast—the intersection of 4 of the world’s 7 major tectonic plates.) When major tectonic plates rub against each other hard enough, they release a tsunami of energy that travels along all the major fault lines, triggering a trail of aftershocks that are, on occasion, bigger than the one that set it off.
The same thing happens in global economics and geopolitics. The fall of a government in one place can change political alliances in many other places, leading to big events many miles away. Watch out for the after shocks that will surely follow the events that took place in Russia this weekend. We have already seen repercussions in Belarus, Turkey, and Kazakhstan. There will be more.
People today, all over the world, are hyper-sensitized to bad news, suffering from a type of PTSD from the extended COVID pandemic. There is a mountain of evidence about the lasting impact of prolonged trauma on people’s behavior. Thucydides, Boccaccio, Camus and others described plagues followed by prolonged periods of lawlessness and violence as frightened people separate into tribes and look for others to blame for their pain. (You can read a review of the literature on pandemics and their aftermath by clicking here.) Plagues and pandemics in history have frequently been followed by decades of social and political stability, changes of government, wars, and volatile financial markets. So too will this one.
There is a reason for these prolonged effects. Eric Kandel won the 2000 Nobel Prize in Physiology for his research showing that prolonged exposure to fear, pain, and other pathogens can triple the number of synapses that connect nerve cells, creating a state of hyper-sensitivity to sudden change. Importantly, he found that removal of the negative stimuli did not return the number of synapses to original levels, i.e., the nerve cells remained permanently hyper-sensitive for the remaining life of the affected brain.
Kandel’s work explains why every decision my parents made during their lifetimes was colored by their experiences living through the Great Depression and World War II. And it may explain certain puzzles about people’s post-COVID behavior as well, including low labor force participation and the reluctance of people to return to the office.
Under these conditions, the best thing an investor can do is to remain calm, maintain a defensive position, and take advantage of opportunities created by the mistakes of other, more emotional investors.
I teach behavioral finance. If we have learned anything from the behavioral economics and finance literatures, it is that making important decisions while under emotional stress is a bad idea.
That’s why I give myself ten minutes of breathing exercises to clear my mind and remind myself how lucky I am to be here before I read the day’s economics reports and sit down in front of the Bloomberg screen. (My preferred app for this is called Balance, with Waking Up as a second choice.) I do the same before I sit down at the keyboard to write these posts.
BTW, if you would like a gentle dose of behavioral finance, Thaler’s Misbehaving (above) is an easy read. Thaler is a legitimate scholar—I have my students read a dozen of his articles on anomalies—and a gifted storyteller. The graphic on the above right is a photo of the inside cover of my copy of the book. I don’t read books; I devour them with notes, drawings, and folded pages. Thaler’s basic premise is that “we live in a world of humans” (p. 6), not the mechanical optimizers found in the economics textbooks, and that economists are just going to have to get used to it.
The views and opinions expressed in this article are those of Dr. John Rutledge. Assumptions made in the analysis are not reflective of the position of any entity other than Dr. Rutledge’s. The information contained in this document does not constitute a solicitation, offer or recommendation to purchase or sell any particular security or investment product, or to engage in any particular strategy or in any transaction. You should not rely on any information contained herein in making a decision with respect to an investment. You should not construe the contents of this document as legal, business or tax advice and should consult with your own attorney, business advisor and tax advisor as to the legal, business, tax and related matters related hereto.