Personal Finance: Measure of disaster is, 'Is it systemic?'

Uncertainty.

One day you think you have a solid strategy for the future, and then the next day the world changes. When unforeseen events occur, we are often forced to question the certainty of our strategies and rethink our plans. Personal and global tragedies usually occur suddenly and without warning. Live long enough and you will likely come to agree with Voltaire when he said, "Doubt is not a pleasant condition, but certainty is ridiculous."

When uncertainty prevails over the securities markets, risk-free investment values go up and just about any investments with risk will go down.

Once fear of the unknown creeps into the psyche of the investor - both institutional and retail, it tends to spread like a late summer wildfire. Disasters - both natural and man-made, often have a profound effect over our certainty of the future and can cause investors to panic.

On March 11 we woke up to news of the horrific events that occurred in Japan as a result of one of the largest earthquakes in recorded history.

In the following days, the U.S. markets began to drop sharply as the carnage had begun to unfold and the fears of a nuclear disaster began to emerge.

UNEXPECTED HITS

A week after the quake, the S&P 500 index had fallen approximately 1.2 percent. One of the index's largest components, General Electric, produces nuclear reactors, so it's reasonable that stock might come under pressure. But why did other companies such as Allstate, AutoZone, CVS, Target and SunTrust lose value?

Disasters create uncertainty, and uncertainty will always cause the markets to react - and sometimes overreact.

HISTORY LESSONS

Here are some market reactions to past disasters

* PEARL HARBOR - On Dec. 7, 1941, the United States entered World War II when the Empire of Japan bombed Pearl Harbor. After the first close of business, the Dow Jones industrial average had fallen 2.9 percent.

The following week, the DJIA was down 4.1 percent and within six months it was down almost 16 percent.

This manmade disaster created a tremendous amount of uncertainty for the future of our country, let alone prospects for economic growth. However, within five years the War was over and the DJIA had increased 52 percent since that fateful day in December.

* CUBAN MISSILE CRISIS - On Oct. 22, 1962, President Kennedy announced to the country that the Soviet Union was building secret missile bases in Cuba.

In response, he demanded that the Soviets remove their bases and ordered U.S. naval fleets to enforce a blockade of Cuba. After several days of teetering on the brink of a nuclear holocaust, the Russian premier conceded to President Kennedy's demands on Oct. 28.

After Kennedy's Oct. 22 announcement to the world, the S&P fell 3.78 percent, but when the Soviets agreed to close their bases in Cuba, the S&P 500 Index was 1.71 percent higher than before the Cuban missile crisis had begun.

* THREE MILE ISLAND - There have been many comparisons of Three-mile Island to the Fukushima Dai-ichi power station in Japan. It appears that the most recent incident, which occurred on the other side of the world, had more of an impact on the S&P 500 than it did at Three-mile Island.

The nuclear scare that occurred in this Pennsylvania city in 1979 caused the markets to fall 1.5 percent by the fourth day. But after six days of uncertainty, the threat of an immediate catastrophe was over, and the market was up 0.8 percent higher than when it all began.

* SEPT. 11, 2001 - The markets were closed for four business days following the terrorist attacks on Sept. 11, 2001. By the end of the first day of trading, the S&P 500 was down 5.5 percent. By Sept. 21, the market reached the trough, down 11.6 percent since Sept. 10, and within a month it had returned to pre-attack levels.

SYSTEMIC THREAT?

Not all disasters have caused uncertainty in the past. In August 2005, Hurricane Katrina devastated the Gulf Coast. By the close of the next business day, the S&P 500 was up 0.6 percent. By the next week, the market was up 2.6 percent and within six months, the market was up a full 7 percent.

Disasters that appear to be systemic can have longer-term effects on the markets. The OAPEC (the Arab members of OPEC) oil embargo in 1973 was in response to the U.S.' assisting Israel in the Yom Kippur War, when it was invaded by Egypt and Syria.

A month following OAPEC's oil embargo, the S&P 500 was down 6.7 percent and within six months it was down 10.8 percent. High energy prices, along with other inflationary factors played a role in a difficult market during the 1970s, that didn't return to pre-embargo levels until 1980.

When we see unrest in Egypt, Libya, and other parts of the Middle-east, perhaps the market psyche goes back to the days of the oil embargo, which lasted only six months, but played a major role in prompting the 1973 bear market.

High energy prices and interest rates were the primary catalyst which pushed the U.S. economy into a recession.

Investors should try to assess the repercussions of a disaster when it occurs. Are the problems short-term? Did the markets overreact? Do you have the fortitude to buy when it seems everyone else is selling? Or perhaps the event will create a systemic albatross causing the markets to get worse before they get better. Look at what history tells us and decide for yourself

Get answers to financial questions on Wednesdays from our columnists who work in the financial services industry. Travis Flenniken, CFA, is vice president of investments with DeMoss Capital - demosscapital.com. Submit questions to his attention by writing to Business Editor Dave Flessner, Chattanooga Times Free Press, P.O. Box 1447, Chattanooga, TN 37401-1447, or by e-mailing him at dflessner@timesfreepress.com.

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