Before looking at one of the specific military risks in Ukraine surrounding this complex geopolitical situation and related sanctions risks, it’s important to consider the market’s past performance during previous wars and high-stakes confrontations.
Historically, military clashes have had limited impact on equity markets both in magnitude and duration—even when the U.S. and Soviet Union were embroiled in the Cuban Missile Crisis.
The S&P 500 fell 6.2 percent, on average, in 18 major post-WWII military conflicts or hostilities that we evaluated. That nearly matches the decline the market suffered when U.S. President John Kennedy and Soviet Premier Nikita Khrushchev were at the brink of war.
While that level of decline is nothing to dismiss, it’s well within the bounds of a typical, modest pullback in many scenarios that often confront markets, including those that have nothing to do with military risks.
Markets tend to bounce back even in the face of serious hostilities and wars
The study of previous geopolitical conflicts indicates the market’s reaction lasted an average of only 30 days before it was able to climb back to even. This occurred despite the fact that many of the actual events lasted longer—sometimes much, much longer.
At times equities weakened during the run-up to a geopolitical conflict as tensions mounted, and at other times the weakness began with direct military clashes. In most instances, markets recovered soon after hostilities began.
As the table above shows, four prior events were more difficult for the market to absorb, with the S&P 500 declining in the low-to-mid-double digits. In these instances, which are highlighted in orange, two of the four acts of war were in the Middle East: in 1990 when Iraq invaded Kuwait and seized its oilfields, and back in 1973 during the Yom Kippur War and Arab oil embargo.
What’s notable about these two events, as it pertains to today’s geopolitical risks, is that those conflicts impacted global energy markets. The geopolitical risks surrounding the U.S./NATO and Russia conflict do not directly put oil and natural gas supplies at risk at this stage (unless the West sanctions Russian oil and gas, or Russia restricts supplies in counter-sanctions). But European natural gas prices could be vulnerable to further increases if the West follows through with its threat to stop the Nord Stream 2 pipeline from becoming operational should Russia and Ukraine clash directly.
In general, when it comes to wars and serious geopolitical disputes, investors should assume that such events can push the equity market into a temporary five percent to 10 percent pullback or, in rarer cases, into a longer-lasting correction of greater magnitude—especially when energy markets are widely affected such that they put medium- and long-term economic growth at risk.
From a longer-run, wealth creation perspective, volatility often presents opportunities. Robust business models, quality recurring economics, large addressable markets, and attractive valuations will always form the basis for quality investments which will surface value over the long run. Buttressed by an improving economic backdrop, accommodative Federal Reserve policy, and quality, positive earnings revisions that indicate companies are on profitable footing, we are constructive on equity markets and look forward to elaborating further (in our next investment journal) the quality characteristics we look for when constructing portfolios for clients.
We invite clients to read the RBC special report entitled “Spheres of Influence”.
Warmest regards,
Grace, Sam, Leslie and Jennifer