Are Stock Markets About To Surge?

This week's midweek commentary is titled:

'Will we see a comeback in equities?’

Empirical evidence would suggest we will.

When will it happen? We don’t know; but one thing history has taught us about the markets correlation to geopolitical events , is that it eventually passes.

I remember asking the same question 2 years ago when markets dropped 33% as the global pandemic struck. We said the rebound would happen and people thought we were mad, as it’s hard to see beyond what’s in front of you. But as traders we have to.

We said it would, and it did.


Most traders and hedge funds were well aware of the threat Putin posed, well before the invasion. Some would say they were also aware of the fact that he was very likely to go through with the invasion.

Everyone did their homework on what might happen and how it would effect the global economy, and this was the conclusion.

Here is what happened to the S&P500 for the 24 hour period surrounding the night of the invasion:

What we always see initially, is panic. Panic from investors keen to pull their money out and panic from institutions uncertain of how to best protect their client accounts.

Here is the same chart, but with the next 36 hours added on:

Clearly, traders around the world had done their homework on Geopolitical events and come to the conclusion that this would be a great time to buy, as the consequences wouldn’t last.

Anyone who panicked and sold out on the morning of the invasion, would have had to watch it go all the way back up, and that is a horrible feeling for any trader; selling the lows only to watch it climb back up just as quickly as it dropped.

Without doubt, this bounce was way too fast. The market should have dropped as a temporary impact would be felt, but the belief that it would recover sent the buyers into panic mode just as the sellers had done 24 hours before.

Given the information available about the history of geopolitical events and the effect they have on the equity market, the market was almost too efficient, and too quick to shrug off the impending consequences.

Data for the last two decades shows global stock markets have mostly ignored geopolitical conflicts beyond a point. Excluding two instances, markets have not only recovered all the losses but also given positive returns within a month of such events.

For example, the Indian benchmark declined 1.2% on June 15, 2020, over Indo-China border tension, but gained 7.6% within a month.

From the start of World War II in 1939 until it ended in late 1945, the Dow was up a total of 50%, more than 7% per year meaning that during two of the worst wars in modern history, the U.S. stock market was up a combined 115%.
 
We appreciate these wars were a long time ago, but it shows the relationship between geopolitical crises and market outcomes isn't as simple as it seems.

Strategas Technical Analyst Todd Sohn says, "In a sad way, I wonder if we’ve become used to it. I wonder if the market has learned to discount these events."

Part of the reason may be purely psychological. Today’s investors have seen the stock market recover from both 9/11, the Great Financial Crisis, and the global pandemic, arguably the greatest geopolitical and economic shocks of our time. This makes it easier for investors to shrug off other events.

"Geopolitical events have rarely left a deep scar on markets but even before events escalated around Ukraine, markets were trying to come to terms with inflation and rate hikes. That’s still likely to be the dominant theme for markets in H1 and beyond," wrote Deutsche Bank in an email to clients.

“These events cause a median drop of -5.7%, they tend to take around 3 weeks to reach a bottom and further 3 weeks to recover. On average the market was 13% higher from the bottom 12 months after”

We are now 3 weeks into the invasion and it has been incredibly volatile to say the least. Since February 23rd, the stock market has moved on any, and all, news out of Ukraine, but the good news is, it does now seem to be moving in the right direction (said with caveats and caution).

On this occasion, it wasn’t just about getting it right as to whether Putin would invade, it was also about getting it right with regards to the impact on the global economy due to sanctions and inflated commodity prices.

Russia accounts for less than 2% of global GDP, so despite the terrible loss of life, the economic consequences should have been relatively minor.

Of course there is still the chance of escalation, but that doesn’t bear thinking about. If at any point this is no longer just a conflict between Russia and Ukraine, then all bets are off and we’re all in trouble.

We are now coming to the end of the third week of the invasion. Every event in the past has been and gone, and equities have bounced back. There is no reason to think we won’t get through this one as well.

The day to day market has become more volatile on a daily basis than anyone could have imagined, but at a time like this, it is always worth looking at one final chart that says it all. If you are ever looking for peace of mind, or a reason to be in the market, here is what US equities have done over the last 15 years:

It is never easy to get into the market when the world around you is still in such disarray, but history would suggest it’s actually the best time to do so.

Buy when it’s low, not when it’s high. The world will keep making money, and individuals will keep investing. Over the long term, all evidence suggests this will keep equity valuations moving in the right direction.

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