How The Crisis Play Book Can Benefit Your Portfolio

What a difference a day makes, right?

On Monday, the bears could be heard telling anyone who would listen that the sky was indeed falling in response to Russia's (NYSE:RSX) "invasion" of Crimea. ("No, really, seriously, we mean it this time!")

The idea being promoted was that Vladimir Putin was doing his best Saddam Hussein imitation by planning to annex some additional beach-front property for Mother Russia. Those traders dressed in their fur caps suggested that the West would object, sanctions would fail and before you could look up the spelling of Ukraine's new President, World War III would be at hand.

Oh, and lest we forget, there was also talk of the economic calamity that was sure to ensue. Remember, Europe (NYSE:EZU) gets one-third of its oil from Russia via pipelines that run through the Ukraine. Therefore, once troops started moving and the drones started flying their bombing missions, the eurozone was sure to sink back into recession. In turn, this would cause the credit crisis to flare up and investors would be back on full-time Merkel watch. Joy.

A Funny Thing Happened on the Way to the Ultimatum

To hear the fast-money types tell it, Tuesday was supposed to be a very tough day to be in the stock market. You see, there were reports on Monday that Russian forces had issued an ultimatum to the Ukrainians that they'd best stand down on Tuesday, or else.

The assumption was that the Ukrainian troops would hold their ground, that Russian troops would respond by force and that the internet would soon be filled with video of the violent conflict taking place in Crimea. As such, holding short positions overnight appeared to be a no-brainer to many.

But the deadline came and went, and there were no shots fired. Well, okay, there were a couple of warning shots fired over the bow, so to speak. But then Russian President Putin mentioned that Russia didn't want to annex Crimea and that military action was a measure of last resort.

Boom. Just like that, the crisis in Crimea joined January's much ballyhooed emerging markets (NYSE:EEM) crisis in the "little crises that couldn't" category.

Soon there was word that Russia's military forces were backing off (reports indicated that the military "exercises" in the area, which had been scheduled for some time, had ended and that the troops were heading home). Suddenly, the fear was gone. Suddenly, the WWIII scenario seemed silly again. And suddenly, the bears were scrambling for the exits to cover those no-brainer shorts.

Were You Surprised?

Let's see a show of hands... who was surprised to see U.S. stock futures up 20 points before the market opened yesterday? And then feel free to nod your head if your reaction to the Dow's 228 surge and the new all-time highs for the S&P 500 (NYSE:SPY), the S&P 400 Midcaps (NYSE:MDY) and the Russell 2000 Smallcap (NYSE:IWM) indices was something akin to, "Wait, what?"

Anyone surprised by Tuesday's spike higher - and this includes the masters of the macro universe who were so sure that things were going to go to heck in a hand basket over the geopolitical tensions in Crimea - forgot one thing. They simply forgot the way the "crisis play book" works.

The Crisis Play Book

One of the most important rules of engagement during a crisis is an oldie but a goodie: "Panic early or not at all!"

Crises in the market tend to be very emotional affairs. The indices "whoosh" lower when folks figure out that there could be a problem. Then fear becomes entrenched and everybody who wants to sell, does so (hence the idea that it is best to panic early).

Once things turn ugly, something eventually comes along to create a sigh of relief. This is called the dead-cat bounce phase. And then, after a retest of the lows, investors finally figure out that the sun will indeed come up tomorrow and those looking for bargains start to dig around in the rubble.

The War Edition

For military conflicts, the game is a little different. The first Gulf War in 1990 was a perfect example for a generation of investors and money managers who hadn't been around during the Korean conflict or Vietnam.

The game plan is pretty simple here. Stocks are sold on the fear of war. Stocks are then sold again once the war begins. But after the bombs start flying, it is how the war is going that dictates the action in the stock market.

In 1990, there was a great deal of anxiety about Iraq's Republican Guard. However, it turned out that there was far more bark than bite amongst this unit and once it became clear that the Iraqis weren't going to put up much of a fight, stocks began to rally in earnest.

The bottom line is that stocks tend to rally when there is a reprieve, a sigh of relief, or, as was the case Tuesday, a de-escalation of a potential crisis. So, the blast higher on Tuesday appeared to be simply following the script, which, by the way, included a boatload of short-covering.

The problem for investors in the near-term is that neither the crisis nor the armed conflict scripts may be in play here. As such, it is probably a good idea to avoid becoming married to any sort of macro view and to let price be your guide for a while.