Tale of two crises

Yet if Dr Strangelove is high on the collective consciousness of web-searchers, then why isn’t the threat of Armageddon more obviously acknowledged in the world’s equity markets?

Sure, one can never know for certain what is and isn’t priced into markets’ expectations; it isn’t as though they write to tell you. Even so, look at how the major share market indices have moved week by week since the Russian army’s tanks trundled into Ukraine on 24 February and you would be forgiven for thinking this was just another normal month in a normal year; nothing special (see Table 1).

There was a bit of a slip in the week to 9 March, but this has been pretty well made up. It leaves European equity markets anything from unchanged in the case of Germany’s DAX index to 2 per cent lower for the Euro Stoxx 50 index. Meanwhile, there is the disquieting sight of US indices showing good gains, while the 6 per cent rise in the technology-rich Nasdaq Composite somehow mixes indifference with ignorance. Do US investors really think mutual destruction is only for Europeans? Just rent Dr Strangelove from Amazon Prime to learn otherwise.

Another way of explaining the markets’ ostensible sang-froid is to point out that people – and therefore financial markets – are useless at making allowances for so-called long-tail risks; the events way out on the distribution curve whose probability factors are tiny but whose consequences are immense, even existential. Such events won’t be unknowable – think of the 2008-09 financial crisis or Covid-19’s global sweep – but will be beyond the power of quantification or of adequate preparation. Major war spilling into nuclear confrontation clearly occupies this category.

To see how equity markets might be expected to react, the best we can do is go back to the Cuban missile crisis of 1962, the previous time the world was so far down the doomsday scenario. The chart does this by taking the daily close for the S&P 500 index of leading US stocks in the 100 days leading up both to the end of the Cuban crisis and to today, which – obviously – isn’t the end of Ukraine’s. To make the two 100-day sequences comparable, each series of the index is re-based to 100.

Clearly, we are not comparing like with like, since the Cuban crisis was short-lived with a definite, and relatively happy, ending. It could even be compressed into a 12-day period from October 16 to 27, although it lingered until November when the US navy ended its blockade. However, it might have begun sooner had US political leaders noticed intelligence reports telling them Soviet nuclear-warheaded missiles were being deployed on the island; somehow, US mid-term elections seemed more important. Yet this also bears some resemblance to Russia’s invasion of Ukraine, which US leaders had been warning about since December without the world taking much notice.

Additionally, if the chart underplays the drama of the Cuban crisis it may be because US equities were already having a lousy year in the run-up to October’s events. From March to late June, the S&P index dropped 26 per cent. It recovered a little during the summer, meandered, then lost 6 per cent during the first week of the crisis before bouncing. By the end of November, the S&P was 16 per cent higher than its crisis low point. Even though it rose more than it fell for the remainder of the year, it ended 1962 12 per cent lower than it started.

Equities’ performance this year has tenuous similarities with what was happening in 1962. Once more, a highly-rated market faltered ahead of the dramatic event. In January, the S&P index lost 10 per cent; not because of the Ukrainian factor but because a combination of high share ratings and rising interest rates are often the cue for a sell-off. Since then, the bounce may be consequential, or it may not. It may signal the business world has no choice but to live with a land war in eastern Europe that may drag on for years. It may signal that conventional warfare that spirals into tactical nuclear strikes then into the real McCoy can be discounted with so little confidence it’s not worth trying. And if, somehow, there were a quick – and relatively happy – end to Ukraine’s war then equities would undoubtedly bounce, but perhaps not that far and, almost certainly, not for very long.

Meanwhile – and prosaic though it may be – we can scan through London’s equities to see which may have been oversold, or overbought, in response to the Ukrainian situation. Hence Table 2, which focuses solely on companies in the FTSE 100; although in the case of gold miner Polymetal International (POLY) and steel and coal group Evraz (EVR), these two have been deleted from the index this week because few brokers will trade their shares; Evraz shares are suspended anyway.

The table shows those five whose price changes have been the most volatile since the Russian tanks went in (volatility being measured by variation around average price changes), those five which have performed the worst and the five best performers. High volatility correlates well with poor performance although, as education services provider Pearson (PSON) shows, it doesn’t have to.

Perhaps what’s most remarkable is that, except for Polymetal and Evraz, no share prices have been slaughtered. The next-worst performer – and nothing to do with the Ukraine situation – is ITV (ITV). The commercial television operator’s acceptable results for 2021 only confirm that, however efficiently it may be managed, it runs on the wrong business model at the wrong time. For proof, consider that in the coming three years it will spend more on programme making than the £3.3bn market capitalisation of its equity; and will then have to continue spending at about £1.3bn a year thereafter. Talk about running just to stand still.

The affairs of the other two poor performers – Rolls-Royce (RR.) and Coca-Cola HBC (CCH) – butt up against the Ukrainian war; very much so in the case of the Coke bottler, which has long had a focus on eastern Europe, but only tangentially in Rolls’ case. The aero-engine specialist may have fewer engines to service as aircraft are, in effect, impounded in Russia. Of the best performers, defence contractor BAE Systems (BA.) and copper miner Antofagasta (ANTO) are war beneficiaries.

Antofagasta’s shares have had a strong run these two years past anyway (at 1,750p they are up 168 per cent), but BAE’s shares have just been making up for ground lost in the past 20 years or so. Instinct says that’s the one I would be taking a closer look at plus, maybe, Coca-Cola HBC. 

bearbull@ft.com