The effects of war on markets

Raazia Ganie and JB Smith
6 April 2022
8 min read

Markets are emotional in the short term but longer term trends are determined by fundamental factors. At the beginning of the year, stock markets declined due to expectations of higher inflation and interest rates. The expectation was that the US Federal Reserve Bank would need to increase interest rates more aggressively. This led to a sell-off in global financial markets.

Then Russia invaded Ukraine and the focus shifted to commodity prices and the impact of these on global economic fundamentals. Shown below is the share of Russia’s contribution to the world in terms of its economy and various commodities.

It is this commodity exposure that pushed the JSE Resource Index and other commodity prices higher. Over the past month, Brent Oil has increased by 18% to a high of $129 a barrel. Gas prices in Europe are up 23%. The price of Wheat is also up by 24%.

We have already felt the impact of these events on global financial markets; next we will see the global economic effect. It is predicted that the Russian economy might contract significantly due to sanctions. This will only have a small impact on global GDP, but the European Central Bank anticipates that the energy crunch might reduce the Eurozone GDP by 0.7%, which is significant.

What will affect GDP is higher inflation (the result of increased commodity prices), and hence reduced disposable income, greater economic policy uncertainty, and heightened geopolitical risk. Global inflation may well stay higher for longer. Although these are clear negative developments there are some positive developments too. Long term structural inflation expectations have remained largely controlled, with no additional pressure towards monetary policy tightening. The broader Eurozone is in the very early stages of the “re-opening trade” after Covid and the policy stimulus currently taking place in China could be a tailwind to the global economy. Emerging markets have largely completed their interest rate normalization cycle. Lastly, there will be windfalls to exporters such as Australia, Brazil, Canada and South Africa due to higher commodity prices.

The prospective direction of the US Dollar has a big impact on the risk of a global recession; this is particularly the case if the USD has significant room to strengthen from current levels, but based on the chart on the left this is not the case.

This explains some emerging market currency gains during the crisis, particularly for high-yielding commodity-exporting currencies like the ZAR.

Most major equity markets are likely already more than 50% into their sell-off relative to historical precedence. The two charts below provide the performance of various markets in US Dollars for two time periods. The first is from 1 January to 24 February 2022 and the second is after Russia invaded Ukraine.

The bulk of the decline in markets took place before the Russian invasion, largely due to uncertainty around inflation expectations, interest rates, and global growth. The war only complicated the outlook for the three above-mentioned variables. However, no one can say with any certainty how long the war will continue, because it has its roots in complex geopolitical aspects.

This means that any review of your investment portfolio will be an ongoing process amidst very high levels of uncertainty. Brace yourself, in other words.

But this is not the first time we have been in such a situation. The table below shows the impact of past geopolitical shocks on the S&P 500.

Geopolitical EventDate of EventCapital Loss Incurred1 month later3 months later6 months later12 months later
Hungarian Revolution23.10.1956-11,00%-2,10%-2,70%-1,00%-11,70%
Cuban Missile Crisis11.10.1962-10,50%3,00%13,70%20,50%26,70%
Prague Spring05.01.1966-10.00%-4,20%-2,80%5,20%8,40%
TET Offensive30.01.1968-9,30%-4,10%5,10%5,20%10,40%
Nixon Shock17.08.1971-9,40%000%-7,10%5,60%11,40%
1st Oil Price Shock03.10.1973-18,40%-4,40%-15,20%-15,90%-38,40%
2nd Oil Price Shock16.01.1979-6,30%-0,80%1,70%3,30%11,70%
Soviet Union Invades Afghanistan24.12.1979-10,80%5,60%-7,80%6,90%26,20%
Berlin War Collapse09.11.1989-10,20%3,60%-0,90%1,90%-6,80%
Gulf War03.08.1990-19,90%-8,20%-11,30%-2,40%10,20%
US Bombing of China Embassy07.05.1999-6,00%-0,80%-3,30%1,90%6,50%
September 11 Attacks11.09.2001-23,10%0,40%4,00%6,90%-16,80%
London Attacks07.07.2005-2,10%2,40%-0,20%7,30%5,80%
North Korea Sinks South Korea’s Ship26.03.2010-10,50%3,90%-7,70%-1,50%12,60%
US Debt Celling02.09.2011-19,20%-6,40%-1,30%5,70%8,80%
US Fiscal Crisis01.01.2013-2,40%6,10%9,50%13,20%29,60%
Debt Celling & Government Shut Down01.10.2013-6,10%3,90%9,00%11,20%14,80%
Paris Terrorist Attacks13.11.2015-13,20%-5,50%3,80%5,50%14,40%
North Korea Nuclear Test06.01.2016-13,20%-5,50%3,80%5,50%14,40%
North Korea Nuclear Test09.09.2016-4,80%1,20%6,20%11,10%14,70%
North Korea Nuclear Test04.07.2017-1,80%2,00%0,00%0,00%0,00%
MEDIAN LOSS-10,00%0,80%0,80%6,80%10,70%

Empirical evidence suggests that the minimum equity losses in prior to geopolitical events have been about 2%, and the highest has been just over 20%. The median loss has been about 10% with positive outcomes 12 months afterward.

These are the historical facts, but the question remains: how should you approach an investment decision within your own investment portfolios during these tumultuous times? The short answer is with caution. It is often also better to remain invested. Let’s consider the returns of equities relative to cash over the most recent major crisis being the Covid Pandemic:  

While cash had almost no volatility, investors who switched to cash would be missing out on the subsequent growth once equities recovered. During the pandemic, equities (using the ALSI as a proxy) returned 60.5% since March 2020 to February 2022. When we compare this to cash which returned 8.9% over the same period, an investor who switched out of equities into cash at the start of the pandemic, lost out on 51.6% of returns over this period. While hindsight is 20/20, we must remember that timing the market is a near impossible task. During times of uncertainty it is better to remain invested as markets tend to recover, especially where the fundamentals of the investment are not affected.

Events such as these serve to remind investors and managers of the importance of a diverse portfolio, with exposure across multiple regions and asset classes. Although we cannot predict when risks will arise, portfolios are designed to survive volatility aligned with articulated risk appetites. Known geopolitical events and risks are considered when investment cases are made. When events such as the Russian invasion of Ukraine arise, analysts will accordingly reassess positions and recommend necessary actions based on sound investment strategies and opportunities available.

We urge investors to remain cautious as the world continues to monitor this evolving situation. The volatility in the market does provide an opportunity to purchase quality, long-term holdings at discounted prices, and asset managers will be taking advantage of these where opportunities arise. NMG Benefits will continue to monitor the situation and manage client portfolios in line with long-term strategies.


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