What does the Ukraine crisis mean for markets?

TL;DR

• An escalation in the Ukraine crisis has led to sharp movements in the the stock market.
• Past episodes of geopolitical tension have led to market selldown in the range of 1% to 20%. However, in most episodes, the market would have a positive return 12 months after.
• The key risks to watch from here are whether disruption to commodity supply could cause higher inflation, and whether the crisis would tip the global economy into a recession.
• In the near term, gold could be seen by investors as a safe “haven”, while commodity prices might remain elevated. However, the market correction could also present opportunities for investors taking a longer term view.

What happened?

If you have been following the news in recent weeks, you would probably have noticed the increasing mention of Ukraine tensions. This comes as the threat of a potential Russian invasion grew with more troops mobilized at its borders and attempts by global leaders to hold peace talks proved futile.

The situation quickly deteriorated on 24^th February, when Russian President Vladimir Putin announced a military operation in Ukraine. This was followed by reports of explosions heard across numerous cities in Ukraine, including its capital city Kyiv.

The stock market which has been jittery for weeks quickly sank. To help you understand what this means for your portfolio, we take a look at what happened in previous episodes of geopolitical tension, how would different assets react, and the risks from here.

Hopefully, this will help you a make a more informed decision rather than to hit the panic button!

What does it mean?

What happened in previous episodes of geopolitical tension?

While we have seen relative peace in recent years, there were previous episodes of geopolitical tension which have also led to similar panic in the market. Here, the maximum selldown in the US market has ranged from just about 1% during the Yom Kippur War (1973) and North Korean Missile Crisis (2017), to as much as 17% when Iraq invaded Kuwait (1990), and 20% during the Pearl Harbour attacks (1941).

According to investment bank Goldman Sachs, an “outright conflict” in Ukraine would push the S&P 500 index to about 4,100 levels, representing another 3% decline from its close on 23 Feb of 4,225. The Nasdaq, Russell 2000, and European markets could see more significant declines.

While news about the outbreak of war definitely strike fear, it would appear that financial markets would usually be less concerned about the impact over time. Looking back at 12 previous episodes of geopolitical events, Truist Securities found that 12-month returns on the US market were positive for 75% of events. The exceptions would be the Suez Canal crisis, Arab oil embargo, and the 2001 terrorist attacks.

What are the risks from here?

With the Ukraine tensions already elevated and already leading to a sharp correction in the markets, what could get worse from here?

• Inflation. Yes, we are talking the much-feared inflation, especially after the sharp rise in the price of goods and services in recent months. Here, Russia is one the world’s largest oil producers. Ukraine is an important location where oil and gas passes through. Russia and Ukraine together account for close to 30% of global wheat exports. One would wonder how tensions in the region could lead to the supply of these important commodities.
• Sanctions. The next development that investors will be looking out for is whether there will be additional sanctions imposed on Russia. On this front, US President Joe Biden will be meeting global leaders shortly and reveal measures to punish Russia for the invasion. So far, Germany has frozen the Nord Stream 2 gas project with the rising tensions. There are concerns that more stringent sanctions could worsen the global supply bottlenecks and drive even higher inflation. Update: The sanctions announced so far were focused on the banks as well as limiting Russian import of technology. However, it would seem like Russian commodity exports would not be cut off. This has helped to provide some relief to the market.
• Recession. Lastly, the dreaded ‘R” word.The key question is whether consumers would cut back on their spending in the face of rising inflation and economic uncertainty. Coming at a time of potential interest rate hikes by the US Federal Reserve, some are naturally worried that this could tip the global economy into a recession.

What would Beansprout do?

• Gold could be a “safe haven”. Gold has long been regarded as a safe haven during periods of market uncertainty, while providing a potential inflation hedge. While gold has climbed to above US$1900/T, it remains below its 2020 highs where it reached above US$2000/T.
• Watch out for rising commodity prices. One of the key themes for us has been inflation, and the Ukraine tensions has elevated the need to guard against rising prices. In this regard, various analysts have suggested that Ukraine tensions could drive oil prices up by $5 to $20 per barrel, depending on the extent of sanctions imposed. Other commodities where Russia and Ukraine are major exporters of, such as wheat, could also see higher prices as supply is disrupted.
• Correction could present long-term opportunities. As shown in the research earlier, markets tend to shrug off geopolitical tensions and recover in the longer term, as long as there is no major knock-on impact that could tip the global economy into a recession. From a technical perspective, markets may see weakness in the short term with heightened uncertainty. However, this could also present opportunities for investors taking a longer-term view of the market.   

Most importantly, do not panic and have a long term plan when it comes to your investments!