After a historically strong start to the year, markets have now pulled back to begin the second quarter. Concerns around geopolitical tensions in the Middle East, inflation, corporate earnings, and other issues have led to a market decline, pushing the VIX index (a measure of constant, 30-day expected volatility of the U.S. stock market) to its highest level in six months. In times of market stress, it’s important for investors to maintain perspective on the critical issues and not overreact to headlines. How can investors understand and remain disciplined during this period of market volatility?

First, tensions escalated in the Middle East due to a direct attack by Iran on Israel. These latest developments only add to geopolitical concerns around the world. Russia’s invasion of Ukraine and the October 7 attack on Israel by Hamas only a year and a half later have already destabilized Eastern Europe and the Middle East. Without diminishing the tragic loss of life and destruction from these conflicts, investors must weigh how such events might impact the global economy, markets, and their portfolios.

Geopolitics can impact markets, the effects are typically short-lived

Geopolitical headlines can be alarming to investors since they are unlike the typical flow of business and market news. These events are difficult to analyze. However, history shows that while geopolitics can impact markets, the effects are typically short-lived. The accompanying chart highlights market returns following major geopolitical events this century. Some events, such as 9/11, changed the world order and had long-lasting effects, even though it was primarily the dot-com bust that led to poor market performance. Other events, such as the war in Ukraine, resulted in higher oil prices which affected inflation and monetary policy. Most of these events did not have long-lasting effects on markets once the situation stabilized.

While today’s conflicts will be closely watched, investors ought to avoid short-term decisions with their portfolios. In the long run, markets tend to recover and perform well primarily because business cycles are what matter over years and decades, despite the events that take place over weeks and months.

Inflation’s persistence has markets rethinking the rate cut path

Second, many measures of inflation have proven to be more stubborn than the markets and economists had hoped. The latest Consumer Price Index (CPI) report for March showed that headline inflation remained hotter than anticipated at 3.5% year-over-year, while core inflation, which excludes food and energy prices, rose 3.8%. Rising shelter costs, i.e., the cost of renting and owning a home, are a large reason inflation has not cooled as quickly.

Combined with stronger-than-expected recent job market data, many investors now anticipate that the Fed may cut rates more slowly this year – or not at all. The Fed’s economic projections have suggested all along that it might cut rates three times this year. Market expectations, however, have swung 180 degrees since the start of the year when some believed the Fed could begin cutting rates in March or earlier. Today this all seems uncertain.

As always, it’s important for investors to keep these expectations in perspective. What matters for long-term investing is the direction of policy and not the exact timing or magnitude of rate cuts. There are still risks to the Fed’s outlook and the monthly inflation numbers, especially if oil prices rise further due to geopolitical conflicts. However, even if this were to occur, inflation is far more manageable now compared to the recent past.

Investors should always be prepared for market volatility

Finally, investors should keep the level of market volatility in perspective as well. The accompanying chart shows that the average year can experience significant pullbacks and that this year’s has been small by comparison. Despite these short-term challenges, markets tend to recover and often end on positive notes. This is why maintaining a diversified portfolio can help minimize short-term risk and increase the odds of financial success over time, regardless of whether markets are volatile due to the economy, the Fed, geopolitics, or other factors.

The bottom line? Markets have pulled back slightly at the start of the second quarter due to changing expectations around the Fed and escalating geopolitical tensions. Staying disciplined and keeping these events in perspective are still the best ways to achieve long-term financial goals.

For informational and educational purposes only and should not be construed as specific investment, accounting, legal, or tax advice. Certain information is based upon third party data which may become outdated or otherwise superseded without notice. Third party information is deemed to be reliable, but its accuracy and completeness cannot be guaranteed. Data and analytics provided by Clearnomics, Inc. Neither the Securities and Exchange Commission (SEC) nor any other federal or state agency have approved, determined the accuracy, or confirmed the adequacy of this article.