Strategy Insight: A Market at War

February 25, 2022
  • Private Banking
Vladimir Putin’s decision to invade Ukraine piles even more uncertainty onto financial markets already burdened with inflation, rising interest rates, and the lingering implications of the COVID19 pandemic. BBH’s Chief Investment Strategist Scott Clemons breaks down the latest.

Vladimir Putin’s decision to invade Ukraine piles even more uncertainty onto financial markets already burdened with inflation, rising interest rates, and the lingering implications of the COVID19 pandemic. The large capitalization S&P500 index peaked on the first trading day of 2022, and has since dropped a little over 10%. This marks the first correction in a bull market that began in March 2020 and lifted stock prices by 114% from the early days of the pandemic through the end of last year.

Corrections are a feature of financial markets. Since 1990, the S&P500 has dropped by 10% or more on 24 occasions, or about once every 16 months. On average, corrections have lasted 82 days, and, from the trough, the market averages a recovery of 11.5% over the subsequent month, 17.8% over the subsequent 6 months, and 23.8% over the following year. Giving into the urge to sell into a downtrend can prove very expensive, as rebounds have happened unpredictably and quickly.  In 20 of the 23 historical corrections analyzed in the nearby table, the equity market was higher – often markedly – one year later.

A Brief History of Market Corrections


This chart shows S&P 500 market corrections that occurred between July 1990 and January 2022. It includes market peaks and troughs, total decline, duration of the decline, and subsequent S&P 500 returns for each of those events.

It is tempting to argue that this time is different, as Russia’s belligerence towards Ukraine threatens to spiral into a larger conflict that extends beyond mere market implications. Indeed, our focus here on the financial repercussions of the war in Ukraine is not intended to diminish the tragic loss of human life, property, and sovereignty that may result. One could be forgiven for assuming that a physical invasion of a sovereign country was an activity consigned to history books, and yet here we are in 2022, watching tanks roll down streets.

We have no crystal ball that will reveal precisely what will happen in Ukraine. When we revert, once again, to the lessons of history, and how markets have responded to similarly unprecedented (or at least ahistorical) developments, the conclusions are counterintuitive. Outside of an immediate impairment of sentiment, equity markets have recovered from geopolitical shocks quickly and robustly. After an average drawdown of 4.3% that lasts 13 days, the S&P500 has recovered its previous peak just 16 days later.

The nearby table illustrates this resiliency. The attack on Pearl Harbor in 1941 – an assault on American soil that drew the U.S. into World War II – drove the S&P 500 down 19.8%. Yet the market recovered all of that lost ground by the fall of 1942. A little closer to our era, the Iraqi invasion of Kuwait drove the market down 16.9% from top to bottom, but recovered within a few months. The truly unprecedented attacks on 9/11 cost the market (once it reopened) 11.6%, but stocks regained their previous peak in a mere 14 days.

Market Reaction to Geopolitical Shocks


This chart shows market reactions to major geopolitical shocks that occurred between December 1941 and January 2020. Some of these events include Pearl Harbor, the Cuban missile crisis, 9/11, and the Boston marathon bombings.  

These are outliers. If anything, this table illustrates how resilient the market has been to developments that one might assume would have lasting negative implications. For example, note the muted market response to the Cuban missile crisis, President Kennedy’s assassination, the Boston marathon bombing, and (relevant to current events), Russia’s annexation of Crimea in 2014. Investors seem to recover very quickly.

This seeming paradox illustrates the difference between price and value, and, although market sentiment (and therefore price) can easily be impaired by geopolitical developments, underlying fundamentals (value) reassert themselves, usually in short order. We may be witnessing another instance of this phenomenon unfolding right now. The S&P500 was down as much as 2.6% during the trading session following the onset of hostilities in Ukraine early in the morning of February 24, but closed up 1.5% by the time the day ended, for an intraday rally of 4.1%. Small cap stocks rebounded 5.2% during the same session, and the tech-heavy NASDAQ rallied 6.8% from the lows of the morning session.

This is not to argue that the volatility is behind us, or that the market correction is over. Volatility, like misery, loves company, and (as the earlier table demonstrates) tends to cluster.  This combination of domestic and geopolitical uncertainty is likely to foster bouts of volatility throughout this year.

Our asset allocation guidelines, investment approach, and manager strategies are not predicated on a particular outcome to the war in Ukraine, a transition in economic leadership at home, trends in inflation, or the Fed’s path to more normal monetary policy. Yet most investors focus on precisely these issues and build portfolios accordingly. This price anticipation approach to security selection requires an investor to know what is going to happen, when it is going to happen, and what it means for asset prices. Attempting to do this consistently and repeatably is a fool’s errand. If we have learned nothing else over the past two years, surely we have learned that the future is forever an unknowable place.

Conversely, our approach is based on the observation that there are really only two mistakes an investor can make: she can buy the wrong asset, or buy the right asset at the wrong price. Our managers seek to mitigate the first risk through careful fundamental analysis, designed to identify durable business models that can thrive regardless of geopolitical developments, interest rate trends, economic cycles and market volatility. In short, we like to own companies that have a greater than average degree of control over their own destiny. We manage the risk of overpaying for these assets through a careful calculation of intrinsic value, coupled with the patience to allow the market to occasionally offer to sell us quality companies for a fraction of our estimate of their true value.

The benefit of this value recognition approach to investing is that it makes price volatility your friend. Volatility – whether of an individual stock or the overall market – creates the spread between price and value that the disciplined investor seeks to exploit.

These are troubling times, and these troubles are reflected in market prices and volatility. History teaches us that patience and discipline – the hallmarks of good investing in any market conditions – are particularly critical in an environment of heightened anxiety.

Past performance does not guarantee future results.

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