I don’t suppose that much thought has been given to how markets price in the possibility of nuclear war. After all, unless you can get your hands on some water purification tablets or iodine, your investment options are likely to have narrowed appreciably by the time we’ve all been irradiated.
Still, there is every chance that sanity will prevail and we will eventually be able to assess whether trade flows have been permanently altered, along with any potential impact on the composition of our investment portfolios.
By now, we are all aware of the 'stay invested' mantra. Remain dispassionate when indexes are on a tear or in retreat. Ideally, your overarching investment strategy should anticipate periods of market turbulence. We know that mature stock markets demonstrate a continual rise in value over the long term, punctuated by downturns. Yet it’s still curious how many investors head for the exits once support levels are breached.
Conversely, however, if you simply put the shutters up to ride out a volatile trading period, you can often miss out on opportunities to invest at lower prices. The initial market reaction (or over-reaction?) to the pandemic provides a case in point, as did the impact of the Brexit vote four years earlier. Perhaps we should learn to embrace volatility. After all, taken to its logical conclusion, if there was zero volatility there would be no price increases – a completely moribund market.
You couldn’t say that about the S&P 500 index based on the latest reading from the CBOE Volatility Index, which is based on the puts and calls for the next 30 days of all the index constituents. The S&P has pulled back by 3.6 per cent over the past month, arguably a relatively modest decline given prevailing macro issues. But the 'fear gauge' has hit its highest level since the beginning of 2021, suggesting that the market is expecting future price changes to be more dramatic than they are today.
At the time of writing, the FTSE 100 had contracted by 1.6 per cent intraday, presumably on news that heavily weighted BP (BP.) would take a hefty provision on the forced sale of its 19.8 stake in Russia’s state-controlled Rosneft (RU:ROSN). Nevertheless, the UK benchmark is trading in line with its 50-day moving average and 4 per cent in advance of its 200-day moving average. This might normally suggest an upward trending market, although it would be unwise to make that assumption under the circumstances.
True, the FTSE 100 initially lost ground when Russian tanks rolled across the border into Ukraine, but it’s hardly the type of extreme reaction one might realistically expect in the face of an apparent existential threat. Some might make the case that the indices have not only decoupled from the 'real economy', but perhaps even from reality itself.
Pundits have drawn comparisons with the Cuban Missile Crisis in 1962, when the US and the USSR engaged in a 13-day exercise in brinksmanship over the deployment of Soviet missiles in Cuba. It is difficult to know whether the situation was more fraught in 1962, but it did result in the establishment of a 'hotline' which was designed to improve communications between the White House and the Kremlin. The fall in the US market was limited to around 7 per cent at the time of the crisis, but US stocks had been heading south since December 1961.
A subsequent investigation by the US Securities and Exchange Commission (SEC) concluded that the sharp downturn was precipitated by a complex group of factors including “rational and emotional motivations”. The SEC report pre-dated the development of behavioural finance theories by about 20 years, but it seems obvious that regulators already had some inkling about 'the madness of crowds'.
UK bank shares have been marked down due to the financial sanctions that have been placed on Russia. And given that western indices remain in heady territory, it’s entirely possible that we will witness a major correction once the dual impacts of rising inflation and an increasing risk-free rate of return work their way through the system. So-called 'black swan' events usually involve investors rushing back to bonds and out of risk assets, although they promptly rushed straight back in again once the initial fears over Covid-19 dissipated.
When and if that does occur, it could provide attractive entry points within a range of sectors which stand to benefit from the geopolitical fallout (so to speak) from the Ukrainian crisis – cybersecurity and defence readily spring to mind – although prolonged disruption in energy markets would weigh on aggregate demand in the global economy. The lesson really is: keep your head even if Vladimir Putin is losing his.
