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How the markets have performed during periods of turbulence
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War in Europe. It's something I never thought I would see in this century. Though I had seen news of insurgencies and revolutions growing up, a full-blown armed conflict between two technologized countries - an invasion by a neighbor no less - was something that seemed very unlikely. And yet, here we are, with Russia launching a full-scale invasion into Ukraine leading to scenes of destruction, mass exodus, and a battle by a populace determined to defend their land.
There are obviously much bigger things to worry about here than the stock market. Human lives have been thrown into disarray and the cost of war is high. Only the next few weeks and months will tell how things will pan out and whether other countries are dragged into the conflict.
But my expertise is in the stock market and in dealing with data. The way I can best put my skills to use is to look at the situation through that lens, and help all of you safeguard your investments. The events have indeed led to a turbulent week - The S&P 500 entered correction territory, dropping more than 10% from its Jan 3rd high, and Dow lost 1800 points before rallying back on Friday. Yet this isn't the first time markets have reacted to war. Let us take a look at how previous conflicts have affected the markets, and what we can learn from them.
Overall Economic Impact of the Conflict
There are five factors that the Russia-Ukraine conflict brings into force: Direct trade, Commodity Prices, Inflation, Supply Chains, and general uncertainty. Let’s dive into how each factor would influence the economy.
Direct trade: US imports very little from Russia directly. It was estimated to be only $35 Billion in 2019 compared to $615 Billion with China during the same period. This was intentionally done so as to minimize the reliance of our economy on the Russian economy after the Cold War. All the new sanctions imposed on Russia would relatively have very little impact on the U.S Economy.
Commodity Prices: This is one of the biggest concerns as Russia is meeting 10% of the global demand for oil. Even though the U.S imports comparatively little Russian oil, since the market is a global one, price increases elsewhere can directly affect our fuel prices. The European market is heavily dependent on Russian gas as you can see below. The cost per barrel of Oil surpassed $100 for the first time since 2014 last week!
Inflation & Interest Rates: The increasing commodity prices can push the already high inflation over the edge. Analysis indicates that if the oil prices increase to $120 per barrel, the CPI could rise as much as 9% in the next couple of months. The ‘transitory’ nature of inflation that the Fed is hoping for might become permanent for the foreseeable future. This would also affect the Fed’s plan to increase the rates in March as usually rate increases are done in a strong market. Hiking the rates in a turbulent market as we are seeing now might push the indices further down.
Supply Chain disruption: High fuel costs and a disruption in sea and air trade routes can lead to supply chain disruptions. While the raw materials for which the US is reliant on Russia and Ukraine are minuscule, Ukraine is a massive exporter of wheat and Russia controls metal markets like Nickel and Copper. It is unclear whether semiconductor supplies will be affected, but if they are, that could trigger chip shortages and lead to a trickle-down effect on dependent industries.
Uncertainty: The most important factor that is affecting the market is uncertainty. Markets hate uncertainty and try to price in for the worst-case scenario. This is perfectly captured in the below chart with the market bottoming out during the start of the invasion and then bouncing back up once the war has started. Even though it does not cover all the conflicts, we can see that in most cases, the anticipation of war causes more drops than the actual war itself. The 2.2% bounceback that we saw on Friday further validates this theory.
On the whole, it seems like the overall market will recover from the dip, but the prospects for oil, wheat, metals, and businesses that rely on semiconductors are uncertain.
How have Geopolitical events affected the stock market?
This brilliant research conducted by LPL Research shows how the markets have behaved during the previous crisis. The S&P 500 fell 5% on average during the last 20 major geopolitical events. But on average, the markets recovered within 50 days and if you remove the two outliers (Pearl Harbor Attack and Iraq’s invasion), the markets recovered in just 25 days. So there is a high chance that the current drop in the market would just be a brief dip.
What about Bitcoin?
Crypto performs remarkably similar to stocks, having a brief one-day dip before gaining back and then some. The highest drops were during the Crimea Annexation and Iraqi insurgency but on average just after a week of the crisis, it was up 7% and after a month it was up 23%.
One important callout is that before 2017, crypto might have not been in such widespread use that Geopolitical developments could have a sizeable impact on them. What we might be seeing here is just the overall trend in the Crypto market (Remember that correlation is not always equal to causation).
So what should we do?
Both existing research and our analysis show that the market tends to price in the worst-case scenario just before the war starts. Once it starts, the markets tend to bounce back within a few weeks, and then it’s predominantly driven by macroeconomic conditions more than the war. If you are invested right now, it’s prudent to stay invested, and if you were waiting for the correct time to buy the dip, now seems to be the right time.
Until next week…
More interesting stuff
Swaggy Stocks: The OG Market Sentiment readers would remember that we had a tool that tracked the sentiment of various stocks. Swaggy Stocks is a much more developed platform with tools for options data, earnings calendar, crypto sentiment, and a dashboard for just tracking wallstreetbets sentiment. They have an excellent market education section as well!
Jesse Cramer @ The Best Interest: My friend Jesse had made an excellent thread on Twitter highlighting the 8 questions we should ask ourselves before trying to change our portfolio due to the current crisis. I am sure 99% of us would keep our portfolio untouched after reading this.
Finally, I couldn’t end this issue without highlighting one of the most inspiring things I have seen in recent times. One quote that has stuck with me for a long time was made by Achilles in the movie Troy (when he is asked to fight for the country to save countless lives):
Imagine a king who fights his own battles. Wouldn't that be a sight.
Well, wonder no more!
If you would like to contribute to the ongoing efforts in Ukraine, you can do so here.
Disclaimer: I am not a financial advisor. Do not consider this as financial advice.
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