With Russia’s invasion of Ukraine, most investors are witnessing the largest military conflict in Europe since World War II. The conflict threatens to break the relative stability that has existed in global economic markets since the fall of the Soviet Union. But how bad can it get for investors?
I first want to acknowledge that people are suffering in unspeakable ways as a result of this war. The Ukrainian people have inspired the world with their courage and resoluteness in the face of a superior adversary. They deserve our respect and whatever support the world can provide to help see them through this atrocity.
A Historical Perspective on Stocks and Wars
As it relates to the stock market: With history as our guide, the markets have generally reacted negatively to the outbreak of conflicts. But no major conflict since World War II has ever caused anything worse than a minor and short-lived correction. In most cases, stocks sold off as the conflict escalated but started to recover soon after actual fighting began. That’s because the markets don’t like uncertainty, and when fighting breaks out, the markets get clarity.
Regardless of how ugly that clarity might be, the markets are able to coldly and rationally assess the situation and then move on. We’re likely to see this conflict escalate, especially with the potential for Russian retaliation against the sanctions. That will almost certainly prolong the volatility for a while. But unless the markets see a probability that this devolves into a deep global recession, it will eventually shrug it off.
There are Still Risks Ahead
But there are a couple of tripwires with this conflict that could threaten the global economy that haven’t existed in recent conflicts. First is the potential disruption to energy supply worldwide, especially in Europe. Russia is the second-largest supplier of energy in the world. Should its energy production be taken offline, it could drastically impact the already tenuous energy supply and demand imbalance, leading to gas price levels not seen before.
It’s not just the energy market that is being disrupted. Russia and Ukraine are two of the largest global suppliers of wheat and fertilizer, responsible for growing food products in Europe, the Middle East, and parts of Africa. Due to the disruption in their supplies, wheat prices have increased more than 50%, and the cost of fertilizers has quadrupled. Not only does that threaten food supplies globally, but it is also adding to the inflation of food prices.
Secondly, though it pales next to the U.S., the Russian economy is still the 11th biggest based on GDP. If it is cut off from the global economy significantly, that could decrease global demand. When 150 million people can no longer buy iPhones, Volkswagens, or Levi jeans, that can move the needle on the global economy. Add in 40 million Ukrainians who are not in a position to spend any money, and the needle jumps a bit more.
Another Wake-Up Call for International Investors
Russia has had to close its stock markets. Investors living on the edge who invested in Russian energy stocks are losing their shirts today. Though that is an extreme situation that may only impact investors who may or may not understand the risks of investing in an autocratic-driven economy, it’s still a stark reminder of the risks of international investing.
However, Russia is not China, which is a bona fide global economic power. So, the chances of investing in U.S. or international companies with significant exposure to the Russian economy are not nearly as great. Still, it bears repeating—as I’ve said numerous times, when investing internationally, investors need to know what they own. Whether investing in China, Southeast Asia, Africa, or Russia, you can’t underestimate the risks that exist.
In a post from 2020 titled, “Why We Sold our International Funds,” we outlined the reasons why investors are not adequately compensated in the form of returns for the risks that exist with international companies. Once you consider currency risks, geopolitical risks, and the risks associated with autocratic governments, the potential returns can never be adequate to justify the investment.
