STOCK MARKETS DURING WAR - What next?
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Hi everyone, in this review we quickly look at the correlation between global military conflict and financial markets.
Today there is serious political conflict between Russia and the Ukraine, whilst a growing Russian military presence is pushing through the Ukrainian border, which many believe could draw NATO and the US into war.
We look at how past conflicts have impacted world markets and attempt to gain insight into what we could expect from the financial markets going forward.
LPL Financial research produced this table, and their chief analyst John Lynch added -
"We would not be sellers of stocks into weakness related to such events, given stocks have weathered heightened geopolitical tensions in the past."
Such a statement is often counterintuitive to how most would react, but lets look at the data for ourselves.
We can see to the left the event and the event date, how much the S&P 500 dropped in one day, followed by the total drawdown from the event announcement, and here the number of days it took for prices to bottom and how many days it took for prices to recover.
On average a crisis event caused the index to drop 1.2% in one day, with an average total drawdown of 5%. The average number of days to reach the bottom was 22, whilst the average days to recover was 47.
Of course, each of these events are unique, therefore putting an average number across all of them is perhaps not the best measure. We can however gain some insight into a typical market response for certain scenarios.
Arguably the closest event to the current conflict was the Iraq invasion of Kuwait, where we saw a total drawdown of 16.9% and a recovery duration of 189 days.
Another interesting study from a financial institute, shows us how risk and eventual reward varied based on the size of the company during times of war.
We see here that during all wars, large cap stocks had a volatility risk of 12.8%, considerably less than small cap stocks at 20.1%.
The return slightly favoured small cap stocks at 13.8% but is arguably unjustified based on the additional risk required.
The difficulty we have during this conflict as opposed to other major historical events, is that Russia is seen as a major global power, with huge military and nuclear capability, and with that comes huge global influence.
Just to put this into perspective for one moment, here we can see a study completed in 2021 showing the nuclear capability ranking by country, with Russia and the USA taking the largest amount by a significant margin, almost half of the world’s nuclear capability is under Russian control.
Russia is also a key producer of crude oil and natural gas with pipelines feeding many areas of Europe, therefore having the ability to cause Gas and Oil constraints across Europe, this too could have a significant impact on those economies through higher energy costs, with the US less vulnerable to such action.
With so much at stake and so much uncertainty its difficult to see where markets are heading this time around. The S&P 500 is currently down 13.7% from its highs in January, so perhaps the markets have factored in much of the concern, but the honest answer is none of us know.
A chief economic adviser at Allianz suggested that investors should be selective when it comes to stock picking within a period of crisis, adding:
"This includes emphasizing on quality trades that are anchored by robust balance sheets and high cash-flow generation”. I certainly echo those thoughts, with all my positions based on companies with good quality metrics.
In summary, the major stock market corrections have generally come from other global financial crisis rather than war, like the 1929 Wall st crash, the Black Monday crash in 1987, the Dot Com bubbl