I've repeatedly warned our readers since July of last year about the negative effect that a significant slowdown in the U.S. economy and rising inflationary pressures would likely have on stock prices.
However, there's another type of potentially destructive force that I haven't yet discussed, namely, "event risk."
Event risk refers to the type of financial risk that can emerge as the result of an unforeseen event, such as a natural disaster, certain types of geopolitical developments, and changes in the regulatory environment.
Although these types of events generally have no lasting impact on stock prices during existing bull markets, they can throw stocks into a tailspin when a bear market is already underway.
Just look at the price changes in the Dow Jones Industrial Average in the table below one year after the occurrence of a negative event.
As you can see in the table above, stock prices (as represented by the Dow Jones Industrial Average) tended to be higher a year after the major geopolitical events outlined in the table — except for those periods during which a bear market was already underway before the occurrence of a given event.
In two of those bear markets, the Dow fell considerably more following the occurrence of an unforeseen negative event. (Although the Dow gained back much of its losses a year after the 9/11 terrorist attacks on the World Trade Center, stock prices in general continued to trend lower through October 2002.)
In the current bear market, we have fortunately not yet faced any major type of event risk. However, we shouldn't assume that there won't be any new terrorist events during the months ahead, or that OPEC won't impose another oil embargo or significantly cut production.
We also face the possibility that the Bush tax cuts, which helped to stimulate the U.S. economy between 2003 and 2007, might be eliminated next year.
So, I recommend that you pay close attention to ongoing geopolitical developments throughout the world and that you also start doing some research on the likely outcomes of the social programs currently being proposed by the persons campaigning to be the next U.S. president.
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