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.
Investors should now consider a new set of questions. What if the Russian invasion bogs down, with large numbers of casualties? What if Russia President Vladimir Putin loses domestic support? What if countries such as Turkey and China turn strongly against the invasion? What if northern Europe reacts with renewed determination to resist Russian aggression rather than increased accommodation? What if other militarily ambitious states take the opportunity to stage their own invasions?
While there are differences in detail among these scenarios, they all mean a more militarized world, something we haven’t seen since the 1970s. War means massive, entrenched inflation, not the transitory supply-chain version that can be easily controlled by raising interest rates. Moreover, wartime inflation is felt most in commodities rather than finished goods or real estate. Despite the destruction of war, it is usually good for investors — at least for those on the winning side. War means resurging nationalism that brings with it higher tariffs, immigration restrictions and taxes. In that scenario, cryptocurrencies could be particularly attractive. (I own Bitcoin and other crypto assets.) It likely means sidelining environmental goals and other progressive issues.
I don’t predict these things will happen, certainly not to the degree of a major war or even a 1970s-era global violence. I also don’t recommend large changes to long-term portfolio exposures based on one day’s headlines. But I do think there’s profit in looking for some potential opportunities that could be winning lottery tickets if the “best laid plans of mice and men” go awry – as usual – than in looking for barn doors to close after the horse has bolted.