War – What Is It Good For?

Even the most ardent news-avoider is likely to be aware of 2022’s early bid to outdo 2020 and 2021 as the worst years in recent memory. Russia invading Ukraine is indeed a strong opening gambit.

I found myself in the dark about any financial ramifications of the war. Sadly many conflicts have taken place during my lifetime, though none have occurred during my investing journey until now. What would the invasion mean for my investments? Did I need to make any provisions in my portfolio for the events? Is it time to buy gold bars, pack a rucksack and head into the wilderness?

I’ve navigated the minefield of conflict-associated personal finance clickbait (“top ten tips to maximise returns from the Russia-Ukraine conflict“, or “these three stocks will protect your portfolio in times of war“) and scoured countless articles, videos, tweets and posts on the topic. I think I have my answers.

The Bear’s Market

For war you need three things:
1. Money
2. Money
3. Money

17th century Italian military officer Raimondo Montecuccoli

This succinct summary on the economics of military conflict demonstrate that the financial cost of war has long been known. It therefore comes as little surprise that the Russian economy is taking a serious pummelling following the invasion of Ukraine.

Institutions are ditching any Russia-related involvement at a frenetic pace, while the Russian fiscal bear has been baited by a flurry of economic sanctions. Both Russian equity markets and the Ruble have performed synchronised nosedives off the 10m board, haemorrhaging value faster than you can say экономические санкции*.

The steep decline of the iShares MSCI Russia ETF following the outbreak of war in Ukraine. Source: iShares
The Russian Ruble follows suit, with a collapse in price vs. the US dollar. Source: XE

Russia’s ~$640bn in reserves should come to the rescue. Yet reportedly half of them are held in countries that are restricting access, limiting Russia’s ability to stem this economic exsanguination. Tightening the taps of oil and gas supply may provide some respite, even if only temporarily.

A run on the banks and a doubling of interest rates are increasing the possibility of hyper-inflation, a worrying prospect for everyday Russkis. I do feel sorry for them – I’m sure the average citizen has little appetite for economic hardship so as to indulge the geopolitical desires of their megalomaniacal dictator. In a dark sense, I do quite like the idea of a ₽1,000,000,000 note to add to my international currency collection.

On a personal level, my portfolio’s direct exposure to Russia is a meagre 0.26%. It means I’m unlikely to feel any sting directly from collapsing Russian markets. Equally, any attempt to shed my pitiful Russian exposure would be little more than sycophantic virtue signalling, without any meaningful impact on anything else.

Russia’s economic exports in 2021. Over half the total value is made up of oil and its byproducts, with goods relating to precious metals making up a further quarter or so. Source: Observatory of Economic Complexity

Nobody can truly say how the Russian economy will perform going forward, although turbulence is very much on the horizon. If we heed the advice of another Italian, Machiavelli said “one must never risk one’s whole fortune unless supported by one’s entire forces“. A military academic is quoted as saying Russia has [only] 75% of its conventional military forces in Ukraine. In that case, it sounds as though Russia risks losing big.

The rest of the world

While the Russian economy collapses in on itself like so many matryoshka, what about assets globally?

Many commentators are predicting further rises in the price of various commodities, owing to the economies of Russia and Ukraine being largely based on commodity export.

Russia’s pivotal role in oil production (10% of global total) may see knock-on effects that will increase energy prices and consequently inflation. Certainly the price of petrol in the UK is continuing to rise; £2/litre doesn’t seem an unrealistic prospect at present. Although Russia only provides 5% of the UK’s natural gas, there may be a further hike in gas/electricity prices too.

A sudden rise in value of Vanguard’s Global Bond Index Fund at the end of February, as investors seek safe investments in potentially uncertain times. Source: Vanguard

On the back of this, some have suggested good bets going forward include:
• Commodities such as oil and precious metals (for obvious reasons)
• Clean energy equities (as nations seek to circumvent reliance on Russian oil/gas) and
• Electric vehicles (Russia provides a sizeable chunk of the global supply of palladium & platinum for catalytic converters)

I’m not sure this is necessarily true. I will, however, be intrigued to see a retrospective analysis of ESG fund performance during this time period once all is said and done. Will they have outperformed classic funds because they tend to eschew ‘sin’ sectors such as oil & gas production, mining and weapons production? Or suffered because of it?

Unsurprisingly the traditional ‘safe havens’ of gold and bonds are seeing some influx. For example, the price of gold has risen by about £100/oz. in the last month – the same increase in price as the whole of the preceding year. Bond yields have also fallen as investors seek safer options.

Tradition would also dictate that riskier assets lose value as investors rein in the risk during times of uncertainty. Cryptocurrencies are a good modern-day example, although the price of Bitcoin has actually increased about 20% in the past month. Perhaps its use as a bypass for classic financial routes is making it an attractive tool for the economically hamstrung Russian, or the Ukrainian devoid of functioning banking infrastructure.

In times of uncertainty one might expect equities to be a poor investment choice as investors choose safer assets. This analysis from historical wars belies that. Source: CFA Institute

That individuals behave according to type is hardly Earth-shattering news. Overall I’m sceptical of anyone trying to tell you that X or Y is a good investment in the current climate. Changing your asset allocation based on the news cycle seems asinine to me.

It’s akin to running a marathon, but deciding on mile twelve that because you passed a runner dressed as Mr. Blobby you’re suddenly going to cartwheel the next mile, sprint the following two and then fail to finish because you’ve expended all your energy on this bizarre new strategy.

Long term outlook

Perhaps counterintuitively, it would seem that conflicts have little intrinsic impact on stock markets. Given that most studies analyse the impact on the S&P500 index, how applicable the results are to global equities is unclear.

The average drawdown following geopolitical events was just 5%, and the average time to recovery less than two months. Source: LPL Research

There is, naturally, still a significant degree of uncertainty and nervousness about the future. Will there be a long, drawn-out conflict that sucks other nations in? Will there be nuclear escalation? Will China decide it fancies some of this annexing lark and invade Taiwan? Reassuringly, the data seems to imply that war, in and of itself, is not a lead weight around economic ankles.

A similar analysis found that the average performance of the S&P 500 a year after various conflicts was +8.6%, and positive in 75% of cases. Source: Truist

Rather, it is the sequelae of conflict that are likely to determine whether there’ll be longer-term detriment to equity markets. How things will pan out in this regard is really anyone’s guess. As I frequently say to my patients, if I had that sort of predictive power I’d play the lottery. Which may well be what you’re doing if you egregiously try to time the market or engage in some rogue new investment strategy based on short-term events. Put down the microscope; look at the bigger, long-term picture again.

What to do?

Some things are happening that we’d expect (rising commodity prices, influx to ‘safe’ assets) and some things perhaps aren’t (e.g. crypto rally, equity stability). It makes engaging with the furore seem futile; attempting to cherry pick winners or buy market dips are hazardous strategies at best. The historical evidence would suggest the conflict is unlikely to have material impact on global equities in the long-term, which is reassuring.

Therefore, the best advice I read was the same simple truths one comes to expect when following a passive investing strategy. Stick to your long-term plan, stay the course. Perhaps that’s disheartening to those hoping to make a quick buck during any war-induced economic uncertainty.

The Plain Bagel makes the excellent point that your approach to risk should be proactive, not reactive. If you’ve already plumbed the chance of short term economic disruption into your investing strategy, then you need do very little when it occurs.

Yes, the question “what changes should you make to your investment strategy during a conflict?” can be answered by another person from history. This time, it’s 1960’s Motown artist Edwin Starr we have to thank:

Absolutely nothing.


Mr. MedFI

*Economic sanctions

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