Could the Ukraine war spark another market meltdown?

When Rus­sia invad­ed Ukraine in Feb­ru­ary it trig­gered a sharp sell-off on stock mar­kets world­wide. The UK’s bench­mark FTSE 100 index fell by more than 7% from peak to trough in just under a month, as the West imposed severe eco­nom­ic sanc­tions on Moscow and com­mod­i­ty prices shot up. 

As of ear­ly April, how­ev­er, the index had recov­ered to its 2022 highs, which was a pat­tern seen across stock mar­kets. Oth­er con­cerns have since begun to weigh on investors’ minds, although mea­sures of expect­ed mar­ket volatil­i­ty remain sharply low­er than when the war began, , indi­cat­ing that investors are less anx­ious about the cri­sis. 

Wars and dra­mat­ic geopo­lit­i­cal events usu­al­ly spark an ini­tial sharp sell-off but rarely have a pro­longed impact on stock mar­kets. US stock­bro­ker LPL Finan­cial shows that since 1941, the S&P 500 has fall­en by an aver­age of 5%, fol­low­ing 20 major geopo­lit­i­cal events that includ­ed the attack on Pearl Har­bor, the assas­si­na­tion of Pres­i­dent John F Kennedy and the Sep­tem­ber 11 ter­ror­ist attacks of 2001. 

In addi­tion, large cap stocks in the US gar­nered aver­age returns of 16.9% for investors dur­ing World War II, 6.4% dur­ing the Viet­nam War and 11.7% dur­ing the 1991 Gulf War, accord­ing to research by Mark Arm­bruster, head of invest­ment firm of Arm­bruster Cap­i­tal Man­age­ment. Typ­i­cal­ly, the index takes just 43 days to recov­er.

“It is some­what under­stand­able that investors often run for the exits in the ear­ly stages of a con­flict,” says John Sim­mons, a senior strate­gist at the invest­ment bank William Blair Invest­ment Man­age­ment. 

“It is a nat­ur­al human instinct to choose ‘flight’ over ‘fight’ in mat­ters of a pock­et­book or a retire­ment account. But blind investor pan­ic can be a mis­take that is advan­ta­geous to longer-term and fun­da­men­tal investors.”

This is in part because his­tor­i­cal­ly con­flicts have tend­ed to have a greater region­al than glob­al effect on mar­kets, says Richard Dun­bar, head of mul­ti-asset research at asset man­ag­er abrdn. 

For instance, Russia’s stock exchange has lost about a third of its val­ue due to the impact of the con­flict  as the country’s cur­ren­cy has fluc­tu­at­ed, and strict con­trols have been brought in to prop up the econ­o­my. 

By con­trast, most big list­ed com­pa­nies in the US and UK have not been direct­ly affect­ed by the cri­sis beyond fac­ing knock-on effects of ris­ing com­mod­i­ty prices or the costs of pulling out of the Russ­ian mar­ket. 

The big­ger prob­lem fac­ing glob­al investors in cas­es like Ukraine is uncer­tain­ty, says Vic­to­ria Schol­ar, head of invest­ment at the trad­ing plat­form inter­ac­tive investor. 

“When signs of con­flict emerge, there are a mul­ti­tude of poten­tial out­comes from a quick res­o­lu­tion at one end of the spec­trum to a world war at the oth­er. As a result, the mar­ket is attempt­ing to dis­count all of these pos­si­ble out­comes with the more pes­simistic fore­cast­ers under­stand­ably sell­ing their invest­ments,” she says.

There are rea­sons to believe the war could fur­ther shake mar­kets, how­ev­er. 

For one, anoth­er sharp sell-off is inevitable if Russia’s aggres­sion spreads beyond the Ukraine bor­ders or Moscow uses nuclear or chem­i­cal weapons. For anoth­er, the inva­sion is dri­ving up infla­tion world­wide at a time when the glob­al econ­o­my faces a series of oth­er threats, includ­ing slow­er growth, ris­ing inter­est rates and a resur­gence of Covid cas­es in Chi­na. 

“The biggest threat to mar­kets is most apt­ly char­ac­terised as a con­flu­ence of many fac­tors,” says William Blair’s Sim­mons. “The war in Ukraine in and of itself is some­where on the list of the threats to mar­kets, but prob­a­bly not right at the top.”

Even before the war, the cost of liv­ing was climb­ing fast in many coun­tries as pent-up demand from the pan­dem­ic pushed up oil and nat­ur­al gas prices, dis­rupt­ed sup­ply chains and forced employ­ers to increase wages to counter staff short­ages (all costs that were passed on to con­sumers). But the inva­sion is now adding to the pain, with the cost of liv­ing ris­ing at its fastest rate in 30 years in the UK, rais­ing fears of an eco­nom­ic slow­down

It’s large­ly due to con­cerns about Russ­ian oil and gas sup­plies being dis­rupt­ed, which has fur­ther pushed up glob­al ener­gy and fuel prices. Rus­sia and Ukraine are also major exporters of min­er­als, ener­gy, fer­tilis­er and food­stuffs, the costs of which have rock­et­ed.

In ear­ly April, the Inter­na­tion­al Mon­e­tary Fund slashed its fore­cast for glob­al eco­nom­ic growth in 2022 by near­ly a full per­cent­age point to 3.6%, cit­ing the Ukraine war and warn­ing that infla­tion was a “clear and present dan­ger” for many coun­tries.

The response from cen­tral banks has been to raise inter­est rates. But that increas­es the cost of bor­row­ing and invest­ing for busi­ness­es and must be han­dled del­i­cate­ly, says Schol­ar.

“A major eco­nom­ic down­turn has the poten­tial to knock mar­kets off course, par­tic­u­lar­ly if cen­tral banks are forced to tight­en mon­e­tary pol­i­cy while glob­al growth slows.”

Investors are, nat­u­ral­ly, cau­tious about the year ahead. David Jane is a fund man­ag­er at Pre­mier Miton. He thinks that “a pro­longed con­flict – as hap­pened in Afghanistan – is sad­ly on the cards, which may not both­er mar­kets too much as we think they are already expect­ing as much”. But he believes that sanc­tions are like­ly to per­sist, Europe will need to pay more for its ener­gy and, with Rus­sia demand­ing rou­bles or gold as pay­ment for com­modi­ties, “oth­er coun­tries are like­ly to want to demand the same”.

While abrdn doesn’t fore­cast any reces­sions in 2022, Dun­bar thinks “it doesn’t take a huge leap of imag­i­na­tion to see how a reces­sion might come about”. He adds that while a peace deal between Ukraine and Rus­sia would be wel­come for Ukraini­ans and mar­kets, many of the prob­lems faced by investors were there before the war and would remain after it.

Schol­ar accepts it’s an uncer­tain time but warns against knee-jerk reac­tions. The key, she says, is tak­ing a long-term view and hav­ing a diver­si­fied port­fo­lio.

“Mar­kets have sur­vived through world wars, the Great Depres­sion, the inter­net boom and bust and the glob­al finan­cial cri­sis. And as any sea­soned investor will tell you, the mar­kets have bounced back.”