The war that began this week between Russia and the Ukraine is a human tragedy and a stark reminder that dollars and cents are secondary to health and safety. Some of us who have friends and family in the areas affected by war are focused on the wellbeing of their loved ones. But for most American investors, the immediate impact of the conflict is seen with the change in the value of their investments.
War is bad for stocks. Companies are worth the present value of their future profits. War destroys wealth whereas work creates it. Wars reduces commerce, making companies less profitable and worth less. That was seen on Thursday, February 24th when the U.S. Stock market opened down 2.5%. It looked like Wall Street might suffer a historically bad day, but by the close of trading the market was up 1.6%, a stunning reversal. The change was more pronounced in technology stocks with Cathy Wood’s ARKK going from -8% to +6%, a 14% intraday change! So what gives?
It’s difficult to know exactly why the market moves the way it does, but yesterday’s price action seemed especially tied to expectations from the Federal Reserve. At the moment, the market is pricing in hawkish moves by the Federal Reserve over the coming year or two. These will take the form of interest rate hikes and the elimination of asset purchases or even asset sales, all to combat inflation.
Those moves are expected to be harmful to the price of stocks, especially growth stocks which are more sensitive to interest rate changes. If war in Eastern Europe is going to be a detriment to economic activity, the Federal Reserve may not act as aggressively which may be net beneficial for stocks. Keep in mind, Ukraine is a relatively poor and small country and Russian Stocks only makes up a small fraction (0.25%) of the equity allocation portion of client portfolios.
There are two main takeaways. The first is that markets are so good at instantly pricing in news. If you had wanted to sell out of stocks yesterday at 10am because of the start of the war, you were too late. The market had already sold off on that news, so selling would have been no benefit to you.
The second is that everything is connected and when one lever is moving over here another level is moving over there. How could the outbreak of war possibly be a good thing for stocks? Because of the Federal Reserve. It’s so hard to know how other elements of the market will react to news that even if you knew the news ahead of time, you still may be wrong in anticipating how markets will react.
Again, we are reminded not to try and outsmart the market. Establish an investment portfolio you are comfortable with and stick to it!