March 7, 2022:
Like everyone, we’ve been riveted and horrified by the Russian invasion of Ukraine. Some clients have asked about investment implications, so we put together a few thoughts below.
For some perspective, Russia represented about 2% of global economic activity, and Ukraine a lot less than that. While the conflict has been terrible for Russian and Ukrainian economies and financial assets, those are a very small part of the whole.
But the war has secondary effects that could cause more significant damage to the broader world economy. Energy and commodity prices have surged, which will certainly exacerbate the inflation problems we’ve recently discussed and raises the risk of recession everywhere by creating higher input costs for businesses and taking money from consumers’ pockets. Europe is especially vulnerable due to its dependence on Russian energy, but even in the US, sharply rising energy prices (which are set on the global stage) can hurt the economy.
The thing to keep in mind is that a bad outcome has already been priced in by the global stock market, which has fallen sharply since the invasion began. Where it goes from here depends on whether the situation turns out better or worse than what the markets have already anticipated.
Looking at past wars and geopolitical events, market reactions have been surprisingly inconsistent, and the downturns typically short-lived. Below is a review of major events from InvesTech Research. Particularly striking to us: a year after Pearl Harbor, a huge attack on US soil that precipitated America’s entry into WWII, the stock market was basically flat. (It’s also worth noting that the 16.8% decline after 9/11 was mostly a result of the already-underway stock bubble burst).
Looking at this table, it’s not obvious that one should buy or sell stocks as geopolitical crises unfold. On average, though, selling out shortly after the beginning of an event has turned out poorly, as bad outcomes were often quickly priced in and markets soon started to look past the crisis. (We also saw a similar reaction during the Covid pandemic, when markets rose sharply against a weak economic backdrop because the economy was doing less badly than markets had previously anticipated).
This time could be different from the average, and there may well be more market downside in the near term. But we feel fairly confident that in due course the global economy will continue its steady long-term ascent, as it has over the 70 years shown in the chart below.
Wars and other panic-inducing crises have occurred on a regular basis through the history of this chart, but the world economy has always gotten up off the mat and started climbing again. Enduring short-term shocks in order to get a piece of long-term economic growth is part of the game for investors.
So we are incessantly reading news like everyone else, but we are resisting panic, sticking to our discipline, and focusing on long-term value. In our portfolios, we have been underweight stocks for a while due to our concerns about the US growth stock bubble, and we lightened up a bit further in mid-February. This gives us significant room to add to our stock exposure should market valuations get a lot more attractive, whether that is caused by wartime market panic, a bursting bubble, or anything else.
We’re ready to act as circumstances evolve, and above all, we’re hoping this terrible situation ends as quickly and peacefully as possible.