In recent weeks, the equity market has continued its quiet advance. Both global and U.S. indices have hit record highs amid low trading volume. On the surface, this seems unremarkable given the market’s slow but steady ascent and the still benign environment of low rates, quiescent inflation and easy monetary policy that is supportive of stocks.

However, if you overlay the market’s recent performance against world news headlines on the front page, rather than the business section, it’s hard not to see some disconnect. In recent months, news headlines have covered the growing disintegration of Ukraine, the victories of anti-euro and neo-fascist parties in European elections, a military coup in Thailand and the U.S. Justice Department indictment of five members of the Chinese military for stealing trade secrets.

Yet, none of these events have prevented stocks from reaching new highs or equity market volatility from sinking to multi-year lows, and they haven’t deterred investors from gobbling up the most speculative forms of high yield. On the working assumption that most investors do read the paper, is this simply a case of cognitive dissonance or are investors behaving rationally? My take: the disconnect may be rational in the near term, but not necessarily over the long term.

In the short term, recent market action isn’t as irrational as it might appear. First, there’s no clear link between these events and near-term economic or earnings growth. Yes, an escalation of violence in Ukraine could lead to increased sanctions against Russia and potentially slower growth in Europe, but thus far none of the parties involved in the crisis seem inclined to up the ante.

Second, over the past five-years investors have been conditioned to “buy the dips.” Anyone who bought equities during the U.S. debt ceiling debacle or the showdown over European sovereign debt has been well rewarded. Finally, while these issues are obviously significant from a geopolitical perspective, some have little systemic significance for the global economy. The events in the Ukraine and Thailand are national in nature, and together these countries account for less than 3% of the MSCI Emerging Market Index.

However, while investors may be right to give a low weight to short-term impact of the front-page headlines, the headlines’ long-term impact may be a different story. Wars, military coups, and sanctions are rarely good for global economic growth. Nor will the pressure to increase military spending – a reality faced by the United States as well as Europe and Japan – help already strained government budgets. If there was a “peace dividend” at the end of the cold war, western governments may face a “geopolitical tax” in the coming decades.

Finally, the growing populism – evident in the outcome of recent European elections – raises the risk of misguided policies that could add drag to an already sluggish recovery. To be sure, none of these potential long-term effects are likely to hurt markets in the near term, but ironically investors are becoming more acclimated to the risks at a time when their cumulative impact may be starting to impact global growth, risk premiums or both.

For investors wondering how to respond to the potential long-term impact of world news headlines, there is no single answer, but I would suggest three rules of thumb: diversify, have some small portion of your portfolio allocated to “cheap insurance” assets that should do well in a crisis, and emphasize value.

On the latter, it’s not that cheaper assets will be immune when and if this year’s headlines lead to next year’s crisis. Rather, it’s probably easier to avoid a meltdown in your portfolio if you own assets that reflect the world’s imperfections.

Sources: BlackRock, Bloomberg

Russ Koesterich, CFA, is the Chief Investment Strategist for BlackRock and iShares Chief Global Investment Strategist. He is a regular contributor to The Blog.

Investopedia and BlackRock have or may have had an advertising relationship, either directly or indirectly. This post is not paid for or sponsored by BlackRock, and is separate from any advertising partnership that may exist between the companies. The views reflected within are solely those of BlackRock and their Authors.

Related Articles
  1. Investing

    Emerging Markets Wary of Fed Interest Rate Hike

    With emerging markets suffering from the economic downturn in China and lower commodities prices, a Fed interest rate hike could be even more devastating.
  2. Economics

    These Will Be the World's Top Economies in 2020

    Discover the current economic forces that are anticipated to significantly shift the landscape of the world's most powerful economies over the next decade.
  3. Mutual Funds & ETFs

    Top 3 Muni California Mutual Funds

    Discover analyses of the top three California municipal bond mutual funds, and learn about their characteristics, historical performance and suitability.
  4. Mutual Funds & ETFs

    Top 3 Japanese Bond ETFs

    Learn about the top three exchange-traded funds (ETFs) that invest in sovereign and corporate bonds issued by developed countries, including Japan.
  5. Forex Fundamentals

    Buying Yuans as a Long-Term Investment: Risks and Rewards

    Examine the current state of the Chinese currency, the renminbi/yuan, and learn whether it is considered a good long-term investment.
  6. Professionals

    How to Sell Mutual Funds to Your Clients

    Learn about the various talking points you should cover when discussing mutual funds with clients and how explaining their benefits can help you close the sale.
  7. Professionals

    Fund and ETF Strategies for Volatile Markets

    Looking for short-term fixes in reaction to market volatility? Here are a few strategies — and their downsides.
  8. Investing

    How Diversifying Can Help You Manage Market Mayhem

    The recent market volatility, while not unexpected, has certainly been hard for any investor to digest.
  9. Investing

    How to Win More by Losing Less in Today’s Markets

    The further you fall, the harder it is to climb back up. It’s a universal truth that is painfully apparent in the investing world.
  10. Personal Finance

    How To Choose A Financial Advisor

    Many advisors display similar skillsets that can make distinguishing between them difficult. The following guidelines can help you better understand their qualifications and services.
  1. What licenses does a hedge fund manager need to have?

    A hedge fund manager does not necessarily need any specific license to operate a fund, but depending on the type of investments ... Read Full Answer >>
  2. Can mutual funds invest in hedge funds?

    Mutual funds are legally allowed to invest in hedge funds. However, hedge funds and mutual funds have striking differences ... Read Full Answer >>
  3. When are mutual funds considered a bad investment?

    Mutual funds are considered a bad investment when investors consider certain negative factors to be important, such as high ... Read Full Answer >>
  4. What fees do financial advisors charge?

    Financial advisors who operate as fee-only planners charge a percentage, usually 1 to 2%, of a client's net assets. For a ... Read Full Answer >>
  5. Is Mexico an emerging market economy?

    Mexico meets all the criteria of an emerging market economy. The country's gross domestic product, or GDP, per capita beats ... Read Full Answer >>
  6. What does a high turnover ratio signify for an investment fund?

    If an investment fund has a high turnover ratio, it indicates it replaces most or all of its holdings over a one-year period. ... Read Full Answer >>

You May Also Like

Hot Definitions
  1. Zero-Sum Game

    A situation in which one person’s gain is equivalent to another’s loss, so that the net change in wealth or benefit is zero. ...
  2. Capitalization Rate

    The rate of return on a real estate investment property based on the income that the property is expected to generate.
  3. Gross Profit

    A company's total revenue (equivalent to total sales) minus the cost of goods sold. Gross profit is the profit a company ...
  4. Revenue

    The amount of money that a company actually receives during a specific period, including discounts and deductions for returned ...
  5. Normal Profit

    An economic condition occurring when the difference between a firm’s total revenue and total cost is equal to zero.
  6. Operating Cost

    Expenses associated with the maintenance and administration of a business on a day-to-day basis.
Trading Center
You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!