What You Need to Know
- The former head of financial market research at AQR Capital breaks down the risks tied to Russia's war in Ukraine.
This will be a cold-blooded column.
I’m not going to mention the horrors of war, nor delve into the history, politics or morality of what is happening in Ukraine. I’m only going to talk about money and, specifically, how investors should react to such events.
Various financial markets mostly reversed or pared their initial moves. Yes, oil spiked, but futures prices indicate expectations of a short-term blip before things either get ironed out with Russia or President Joe Biden removes blocks to U.S. domestic production and strikes deals with countries such as Iran to produce more crude.
The Chicago Board Options Exchange Volatility Inc., better known as the VIX, rose, but most of the increase occurred in the last few weeks. Stock and bond markets outside of Russia showed only mild reaction, with the S&P 500 Index reversing a loss of as much as 2.62% to end 1.5% higher, and inflation expectations have not changed much.
This is consistent with history. Since World War II, military aggression has generally led to a few weeks of heightened volatility but little lasting impact on markets. The year following aggression events have been slightly better than average for investors.
But investors should beware. The great Prussian military theorist Carl von Clausewitz wrote, “War is the realm of chance. No other human activity gives it greater scope: no other has such incessant and varied dealings with this intruder. Chance makes everything uncertain and interferes with the whole course of events.”
The one prediction I’m confident in making is that nothing will go as planned for anyone. In these circumstances, there are no safe bets.
Any defensive preparations had to have been made by investors prior to the invasion, and market prices and data make clear that investors have been reducing risk in this year.
It seems investors remembered that the best defense is a good offense, with the market’s version of that adage being buy the rumor, sell the fact — prepare for downside when Russian troops are massing at the border, put the risk back on once they cross it.