Some poignant, emotional lines above that really put things in perspective. But what follows is a rational message for those investors looking for direction today.
Just as the world is healing from a deadly pandemic, we are staring at an impending war. Any act of aggression between nations leads to a catastrophic loss of lives and suffering. The 2021 Global Peace Index1 estimates that the economic impact of violence in 2020 amounted to a massive $14.96 trillion which is equivalent to 11.6% of total world GDP or equivalent to the size of Switzerland, Denmark, and Ireland’s economies put together.
The impact of political aggressions and efforts to destabilize geopolitical debates resonates throughout financial markets. Let us then take a look at how investing is impacted during times of war and peace.
The correlation between war and investing
War has always been an existential threat to humanity and the ensuing mayhem often leads investors to parking their money in safe-haven assets - primarily gold and the US dollar. Whether the uncertainty is intensifying tensions between countries or industry-wide disruptions by a global pandemic, gold prices have shot through the roof to touch multi-year highs. These events cannot be predicted, but investors who have diversified their portfolio are sure to be in good stead. Similarly, demand for short-term assets denominated in the US dollar grows leading to a depreciation of the dollar against other currencies. Whether this depreciation of the US dollar has a significant positive or negative impact on your holdings depends on how sustained the times of uncertainty preceding formal conflict are. This is, in fact, true for the broader equity market as well.
Rising diplomatic tensions lead to high market volatility. However, the falling prices driven by low investor confidence may be short-lived unless the fundamental business model of your portfolio companies is impacted by the states involved. And it is for precisely this reason that international conflicts tend to have a stronger impact on stock market indices than internal ones. Commodity prices are naturally quite reactive to any events in the Middle East, and now, Russia, which has emerged as the 2nd largest exporter of crude oil and contributes to 10% of global oil production. If your investments include companies in industries such as travel, heavy manufacturing such as cement or rely on petroleum-based inputs, it is crucial to weigh the long-term business prospects of your holdings.
If the conflict sustains, the sectors that are impacted in the medium term by conflicts such as the Russia-Ukraine crisis tend to be quite broad-based. Hospitality and leisure are temporarily disrupted, airlines bear a double whammy with lower demand and high cost of jet fuel. Uncertainty may lead to central banks softening their stance on interest rates as well and banking stocks that typically benefit from rising interest rates tend to lose sheen. Rising crude prices lead to falling EBITDA margins for fast-moving consumer goods companies which they may or may not be able to pass on to end consumers depending on the product categories they are present in. Any price increases in commodity, undifferentiated products may lead to a shift in consumer preferences. Hence FMCG companies may see some margin compression. Given rising input prices, prices of industrial goods may go up as well. On the other hand, defense stocks stand to naturally benefit.
The correlation between peace and investing
However, the increased economic activity during peacetime outweighs the defense industry gains. A cocktail of factors such as stable currencies, relatively open trade, workforce development, increased investments, regulatory reforms drives economic growth during prolonged periods of peace.
The Institute for Economics and Peace predicts that over the last six decades, GDP growth has been three times higher in highly peaceful countries2, as measured by the Global Peace Index, than in countries with low levels of peace.
Not constrained by war or terrorism, innovation thrives. The ongoing tech boom has been possible due to an enabling environment of ease of global connectivity, investments in human capital, and openness of consumers and businesses to adopt new ways of doing business since overarching issues about the stability of their country and loved ones are not in the picture.
Further, agile companies have the opportunity to pivot and capitalize on emerging arenas based on their existing strengths. For example, Pfizer, now one of the world’s largest pharmaceutical companies in the world, was once a citric-acid manufacturer who was asked by the US government to participate in the production of penicillin3. Pfizer pivoted from producing citric acid for packaged foods to compounding on its pharmaceutical experience gained during wartime. More recently, Indian textile manufacturers who lost out on their traditional exports business were flooded with requests for fashionable masks.
Being cautious and quite often pessimistic, investors stay away from investing in unstable countries. However, countries that are recovering from war invest in their infrastructure and re-build industry capacity. Almost contrary to traditional wisdom, World Bank studies show that early investments in countries that have the potential to improve in peacefulness will see up to 8% higher returns on the back of improvements in the macroeconomic indicators.
Post WW2, many countries focused on strengthening physical infrastructure, such as Japan's relentless attention to building high-speed railways. However, McKinsey predicts that in the 21st century, digital capabilities are likely to be the most important infrastructure investment4. Investments in four sectors alone—mobility, healthcare, manufacturing, and retail could boost global GDP by as much as $2 trillion by 2030.
The correlation between emerging asset classes and war
This discussion has covered equity, bonds, and currencies but with millennials and Gen-Z increasingly parking their portfolio in relatively new asset classes such as cryptocurrencies, it is worthwhile examining how these are impacted by political tensions. Although cryptocurrencies such as Bitcoin originated from distrust in the financial system, cryptocurrencies have shown a strong correlation with equity markets. Being risky assets, investors have fled leaving crypto markets bleeding. On the other hand, Ukraine has interestingly raised cryptocurrency worth almost $13 million in donations5. So these new-age assets are defining their own role in the rising geopolitical tensions.
What can we learn from this?
The effects of wars and conflicts go beyond battlefields and inflict severe damage to human and physical capital, often with shattering economic consequences. Analysis of past investing data throws up largely two important themes - the importance of diversification across asset classes and sectors in your portfolio and the golden opportunity to add or buy quality stocks in the dips driven by geopolitical conflict.
These are long-held investing ground rules, the importance of which is only being reiterated in these unpredictable times. Panic among investors and everyday discussions with friends and family is natural but may be unwarranted.
So if you, as an investor, find yourself rattled by geopolitical rivalries, worried about how to invest wisely in midst of all this, one amicable solution could be to go back to basics- the simplicity of diversification among different kinds of mutual funds. Especially during tumultuous times, the various factors influencing your potential returns are generally fast-moving, which makes cherry-picking among stocks an arduous task (atleast for those who aren't full-time traders). Mutual funds, on the other hand, come backed by the expertise of the fund managers whose primary job is to monitor the market, analyse risks, build a well-thought out portfolio, try to buy the dips and capitalize when possible on windows of opportunities arising from uncertainty. While mutual funds are also exposed to as much risk as their underlying assets, the risk-reward is possibly better managed by professional experts than when you try to DIY (do-it-yourself) or time the markets.
While many investors may find it difficult to not take emotional decisions at times like these, the wise ones know the best course of action is generally to ignore the crazy noise (especially if you are a true 'investor'- by definition, a fan of long term thinking & actions), keep calm and be Zen. Stick to your plan, remain rational and think of uncertain times like these as a time to 'put more in'. If still unsure, talk to an expert financial consultant like a Mutual Funds Distributor who will be able to help you see through the tunnel, towards the light.
And if we still have your attention, check out our own arsenal of products here.
Here's hoping the world sees reason where it best lives- in peace. 🙏🏼
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