Exogenous Shocks

What's an example of an event in recent history that ultimately had a global impact on markets?

That's right. External events aren't priced into the market like long-term trends. That's because these external events aren't easily predictable.

No. External events won't be directly captured in market prices.

No, actually. External events can definitely be a shift, but they're not reflected in risk premiums.

Other exogenous shocks may come from new products, markets, and technologies. But too often, analysts are focused on the short-term benefits and miss out on the impact to TFP growth. Always remember as an analyst that it's important to evaluate shocks in the context of future trend impacts and carefully monitor key economic variables.

One such economic variable is oil. Just think about what oil supply and demand issues can lead too. Many times, crises in the Middle East result in oil price spikes. So what should you be on the immediate lookout for if an oil crisis occurs?

Quite right. You'll be on the lookout for inflation, as supply restrictions will cause the price of oil to increase. This will lead quickly to price inflation, which will then eventually restrict employment as businesses spend more on a key input, opening up an output gap. Coming full circle, inflation then drops as unemployment increases. Occasionally, there have been periods where oil prices drop, which tends to lengthen any economic upswing because of lower inflation. But this can also lead to economic overheating.

No. Sadly, military conflict is sometimes part of Middle East oil issues, but that's not an economic variable.

Nice try, but no. Long-term trend changes in renewable energy sources could be a factor to consider, but it's not an immediate issue.

Speaking of overheating, exogenous shocks can also come in the form of financial crises that result from overheated markets. Bank or investor confidence can become increasingly mispriced and lead to a financial market collapse. Thankfully, central banks have increased their awareness of these market risks and have been willing to step in and support markets through both conventional (interest rates) and unconventional (quantitative easing) methods. But it remains to be seen how central banks will act during a significant financial crisis that occurs during a period of low (or even negative) interest rates.

To summarize: [[summary]]

Indeed. The horrible tragedy was shocking, and practically everyone in the world was impacted as markets, travel, and business ground to a halt. It was a global event.

In fact, all three of the events listed affected global markets, even though the events were external to markets. Such events are called __exogenous shocks__, incidents from outside the economic system that nevertheless impact its course. These events could be a terrorist event, natural disaster, or more commonly, a shift in government policy (which is why investors closely watch new government administrations, voting results, government measures, and the overall direction of governments).

Exogenous shocks can have short-lived effects or actually drive changes in trends. Consider the difference in pricing an external event versus a long-term trend. When it comes to external surprising events, how do you think the market prices in these events?

Indeed. News of the results sent shock waves around the world.

Indeed. The horrible tragedy was shocking, affecting not only the local economies, but also international shipping and travel markets.

The 2004 Indian Ocean tsunami

The 11 September 2001 terrorist attacks

The 2016 referendum results that initiated Brexit

Inflation

Military conflict

Long-term trend changes to renewable energy sources

They aren't priced into the market

The underlying trend change is reflected in market prices

They cause a structural shift in risk premiums, so they are reflected in prices

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