Conventional stock market wisdom says investors should buy when the cannons roar and sell when the stock market hears the clarion call. The cannons are literally roaring today. But does this reasoning hold true?
Author Ben Carlson has written extensively on the relationship between war and stock market performance. However, the relationship between geopolitical crises and market performance is not as obvious as you might think, he argues.
Wars, threats of war and geopolitical tensions can cause considerable damage in equity markets. That is in the short term, because in the long term you rarely find such problems on the charts. That is the good news, if any. However, investors prefer certainty and stability, and that is clearly lacking.
Liquidity
In the six months following the outbreak of World War I in 1914, the US Dow-Jones index fell by more than 30 percent as business came to a standstill. Liquidity had dried up, so the decision was made to simply close the market.
That lasted for no less than six months. But after the reopening in 1915, the Dow rallied by as much as 88 percent. To this day, that remains the highest annual return ever for the Dow. From the outbreak of war in 1914 until the end of the war in late 1918, the Dow had risen a total of more than 43 percent, or 8.7 percent on an annual basis.
Market performance at the beginning of World War II was also notable because after Hitler invaded Poland on September 1, 1939, and the market opened on September 5, the Dow rose 10 percent. Carlson wrote that when the attack on the US naval base at Pearl Harbour took place in early December 1941, the stock market fell 2.9 per cent the following Monday, but it took barely a month to recoup these losses.
Today
In a recent analysis, Thomas Planell, administrator-analyst at DNCA Finance, writes that with the exception of coinciding crises, or crises that were the direct cause of a recession (the Suez Canal crisis in 1956, the oil embargo in 1973 and the attacks of 11 September 2001 in the midst of an economic crisis), the old stock market adage usually comes true.
“’That was also the case in 2014: the annexation of Crimea by Russia left the markets virtually unaffected. Western companies have relatively limited exposure to this market, which is dominated by local trading partners. The markets that were punished the most were those whose activities in Russia were indirectly affected by the sanctions against the Federation. But a month after the start of the annexation without resistance or bloodshed, the DAX lost no more than 2 percent. The Stoxx 600 Europe 1 percent. Oil stocks performed only slightly above the rest of the trading landscape.”
More sensitive
Nevertheless, markets could be slightly more sensitive to a military escalation in Ukraine than in 2014, Planell said.
The energy situation in Europe has been particularly tense for several months. If the Ukrainian taps are turned off for two or three weeks, it could lead to an additional 10 to 20 percent increase in gas prices that are already astronomically high. It could cost 15 to 20 basis points of economic growth in the eurozone due to the impact of energy prices on private consumption and the risk of supply problems for industry combined with production delays, such as for example in chemicals.
As a reaction to possible European sanctions concerning Nord Stream 2, Russia could also decide to reduce its supply to the continent for a longer period, which could exacerbate this prediction, especially for Germany.
The DAX, which does not include oil companies, but where energy-hungry sectors such as chemicals or industrial goods and services are strongly represented, could prove the most vulnerable index, the DNCA analyst concludes.