An old investment saw, from one of the Rothchilds (Nathan), has it that an investor should “[b]uy on the sound of cannons, sell on the sound of trumpets.”
There is truth to this maxim, which resembles, and inverts, a more commonly known one: “Buy on the rumor, sell on the news.”
Tom McClellan has researched the question and found that the lead in to war is generally bearish for stocks but that the period near the outbreak of war is bullish, consistent with the first part of Nathan Rothchild’s statement. “Actual wars are usually bullish. But the descent into war is bearish.”
A case in point is the selloff that occurred in the summer of 1990 in the weeks before Desert Storm.*
It’s tempting to believe that geopolitical conflict, like the one we are witnessing now between Russia and Ukraine, would be obviously bearish for stocks. But because the stock market is a forward-looking discounting mechanism, the outbreak actually reduces uncertainty and provides market participants with a better sense of where the economy is going and the earnings of individual companies. As a result, the effects of a full-scale Russian invasion are already priced in.
Barry Ritholtz has pointed this out more generally, charting the market’s reaction to numerous geopolitical conflicts over the decades.
Notice how the market tends to shrug off geopolitics for the most part. According to Ritholtz, “[m]ost of the time, markets are hardly affected by these sorts of terrible events. Even the US entry into World War 2 after the Pearl Harbor attack took a little more than one year to recover. The worst war in human history and markets were higher in 307 days (it did take 143 days to bottom).” Additionally, two of the bear markets during this 80-year time frame, from 2000-02 and 2008-09, occurred without major geopolitical events preceding them.
Ritholtz is further correct about the way our perspective can be distorted in emotionally charged times such as these, overweighting the the shock and horror of the moment and overlooking favorable long-term trends that continue on:
“The lesson here is to never bet against human ingenuity, creativity, or progress. In the face of horrific existential threats, while the headlines are terrible, gradual improvements are always taking place beneath the surface. Morgan Housel likes to say that ‘Progress happens too slowly for people to notice, while setbacks happen too fast for people to ignore.’”
Where does that leave stocks in 2022? We have already seen significant declines in stocks, especially in the tech/growth sector, at a level where the Nasdaq has rallied since the start of this long-running bull market. It doesn’t mean that stocks can’t go lower, and it doesn’t mean that stocks can’t chop sideways for months. But risk-reward metrics are looking better for stocks now than since last November.
On the other hand, wars are inherently inflationary, and the recent economic sanctions levied against Russia could easily create additional inflation, causing the Fed to tighten liquidity and risk a recession.
Real assets, like oil, gold, commodities, and real estate, continue to be favored over financial assets, like stocks and bonds. This is a key reason that the typical 60-40 portfolio of stocks and bonds has not fared well recently. To that end, Stillpoint clients have seen their portfolios diversify into real assets to be positioned for gains in these areas.
*Note that, as with 1990, 2022 is a mid-term election year. Mid-term election years frequently see large declines in stocks, but that stocks typically surge in the 12 months following the bottom that year, often after the elections occur and uncertainty declines, as in 1990.