Impact of Ukraine-Russia conflict
These are times of great uncertainty in the market. Last month, we discussed the economic situation regarding rising inflation which would most likely lead to increased interest rates in the short term. This in itself already caused a lot of uncertainty in the markets.
Now, Russia has invaded Ukraine, leading to even more uncertainty in the markets. To better gauge the potential impact these events have on the markets in the short-, to mid-term, we’ve decided to look back at previous wars and what impact they had on the financial markets. Hopefully, this gives us a better understanding of what we might expect in the future.
Impact of past conflicts
LPL Research has researched the impact of important geopolitical events on the S&P 500, the US stock market. Although the most logical thing one might expect is a strong downturn of the market, the reality is a bit different.
As can be seen in the overview, these events lead to a drawdown of the equity markets. However, these drawdowns are usually not that severe as good recoveries follow them. They mostly occur when unexpected events happened. When anticipated, they have less of an impact as markets tend to show bearishness in the lead-up to the events.
The conflict in Ukraine started on the 21st of November 2013 with the annexation of Crimea by Russia that occurred between February and March 2014. During this period, the maximum drawdown for the S&P 500 from the start of the conflict was about -2.5%, reaching within two and a half months after the start of the conflict.
So history tells us that markets will react but not as severe as some might initially expect.
Unsurprisingly, Russia’s MOEX index saw a drop of almost 50% in the past few days.
Why this time is more severe
The largest difference between this conflict compared to others since WW2 is that this concerns a possible massive war within Europe as it involves a significant amount of troops and equipment from a superpower. Further escalation is still possible in Ukraine.
The impact on economies worldwide is expected to be a lot more severe this time as a lot of economic sanctions will be used between the West and Russia. This could hit global economies quite hard. As Europe is dependent on Russia’s gas, it will not be surprising to see energy prices there rise significantly. Oil prices will rise as well as the conflict drags on as Russia is one of the largest oil producers in the world. Uncertainty about its production or eventually even lower output can lead to higher prices. We have already seen this happening lately. After the attack on Ukraine, Brent and WTI oil prices shot up to over $100 per barrel for the first time since 2014.
Furthermore, no one is certain yet on how far Russia is willing to go, meaning that a lot of uncertainty about the severity of the conflict still exists.
Considering that economies can be hit quite hard due to the fallout of the Ukraine-Russia conflict, speculation has begun on whether or not central banks will start to hike interest rates. This was expected to happen in the US next month on the back of increased inflation and a more stable economy. As global economies, including the US, might get destabilized again, central banks such as the Fed might hold back on raising interest rates which could be seen as a positive for the economy and equity markets.
We have already seen the first ECB official to call for the continuation of its “bond-buying stimulus program at least until the end of the year and keep it open-ended to cushion the fallout from any conflict in Ukraine”.
So if history has taught us anything, it is that the US equity market feels the effects of conflicts like these, but does not get hit too hard. Europe is expected to suffer a bit more. And while conflicts usually do not hit the equity markets too hard, there remains the risk of further escalation.
Eyes should be on how much further this escalates as well as what the stances will be of the central banks in the coming days as that could determine the direction of the market.
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