Russia-Ukraine Conflict

News of Russia sending missiles over to Ukraine is all over the minds of people right now and it is a cause for concern. After all the COVID and stagflation woes, and we thought that we had enough, we are presented with a geopolitical conflict that has sent shockwaves over the Internet. Negative news has relentlessly bombarded the markets much to our dismay.

The very first impact that we have experienced would be the tumbling of the markets on the day the missile was launched and much to our surprise, the market rebounded just a day after. Quit playing with our hearts, will you?

Cross-border conflicts have been rare in the recent years with peace treaties and the UN’s watch. But let us see what history has to offer in shedding some light on the post-war performance.

This table, sourced from Reuters, depicts the post-war gains. About 41% of the time, the broad market index S&P500 has recovered within a week. And, about 83% within a year. For the occasions that we zoom into that suffer a 1-year loss, we quickly realise that these are also periods of long-drawn recessions or conflict.

For example,

1. Oct 1956 Suez Canal Crisis was followed by monetary policy tightening starting Aug 1957.

2. Dec 1989 Invasion of Panama was followed by the Fed responding to inflationary threats by increasing interest rates up till 1989, along with the 1990 oil price shock, debt accumulation across the 1980s, and poorer consumer sentiments. And this was only a small brief recession.

3. Oct 2000 bombing of Yemen and Sep 2001 bombing of World Trade Centre was followed by the dot-com bubble.

These examples may imply that the 1-year long recession may not be entirely due to the war itself but other fundamental economic reasons.

But it is concerning that in the most recent 15 years, there has only been one geopolitical conflict as Russia invades Crimea. The stock markets recovered, nevertheless. Will history repeat itself?

We have to take note that we are in the midst of scary inflation levels that may mimic Examples 1 and 2, and we may have our small tech bubbles popped recently with sky-high valuations that seems reminiscent of Example 3.

No one can predict the future and how the markets will respond. The invasion of Ukraine right now may find itself worse off on a physical scale and the equity market may plunge. Or, in fact, if the US or China keep their hands out of the conflict, our markets may not take the hit.

The situation looks grim but take heed that the broad market will generally recover. Perhaps, we can also pinpoint sectors that will get heavily hit and become extremely volatile – commodities such as Nickel, Oil, and Wheat especially. Sectors across Energy, Supply Chain, Manufacturing, and Food may be severely impacted. By no means this is an investment advice, but investors can either take the volatility to their advantage if their risk appetite calls for it, or to totally avoid these sectors and those closely related.

Across geographies, it may be rewarding to look at economies that may be slightly decoupled and unaffected by such geopolitical tensions. In fact, India has been doing great in the recent years with the S&P heading up by 87% from COVID’s low while India’s NIFTY50 has boasted a 108% growth since then (prices as of 25 Feb). With the economy back on track for India and with more developments to come, the darkest days may be over and perhaps it may be worth a look.

Japan on the other hand has been criminally undervalued from being under the radar – Japanese stocks, in my opinion, are slightly under-published to the public and thus lack the catalyst for a fair valuation. Although most retail investors may not have the access to these markets, funds offered by asset managers may be of interest to some.

A mini project on Japan’s stock market that I have carried out by taking the top 100 stocks and the bottommost 150 stocks, my hypothesis is that small caps are more undervalued compared to large caps due to the lack of media exposure and thus no chance of a catalyst.

Data is filtered by choosing only stocks with a positive Earnings-Per-Share (EPS) ratio to put small cap stocks’ profitability comparable to those of the large caps. This is because some small caps (nearly 2/3 of the listed stocks) may have a lack of cash flow, high operating costs, temporarily unprofitable, or with business models in under improvements. It is also easy to filter out EPS while stock screening and thus not cherry picking. What remained were 66 small caps and 75 large cap stocks. Number of publications are done through looping the search of the companies and doing a count of the number of articles Reuters have on the names. (Thank you Gabriel for helping me out on this!)

Results from a simple comparison across sectors show that large cap stocks in most sectors have a higher valuation, using Price-to-Earnings (PE) ratio as a proxy. The exceptions being commercial services, consumer non-durables, and distribution services. Possible reasons could be due to consumers having more information on them since they are directly linked to our daily living, and thus having sufficient exposure for investments to roll in.

Of course, I must recognise that selection bias of performance may occur since perhaps transportation, technologies, finance, or manufacturing may require a larger consumer base (and thus larger cap) to gain sufficient economies of scale to outperform. And, after all, it is a simplistic analysis done.

Nevertheless, Japan equities seem to show a promising future especially with the all-hyped Abenomics that seems to be working and keeping a healthy inflation rather than a deflation that Japan so fear.

All in all, geopolitical tensions can be scary, and it may be many whammies put together at once in this very time we live in. An investment strategy that I would love to adopt is to divest into other economies to ease out the volatility that we may soon face. And remember, these are not investment advice but rather, nuggets for consideration!

If you're interested to chat on this topic or to exchange ideas, please feel free to drop me a message on Telegram @elijah2212, LinkedIn, or through email elijah.thj@gmail.com!

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