INSUBCONTINENT EXCLUSIVE:
Even during major conflicts, financial markets have often operated relatively smoothlyLondon: The economic consequences of armed conflicts
have received widespread attention at least as far back as when John Meynard Keynes wrote about them in 1919 in relation to the first world
war.Yet as the world braces for a possible war in Ukraine, we still know relatively little about the interplay between conflicts and
financial markets.One thing we can say is that even during major armed conflicts, financial markets have often operated relatively smoothly
A clear example is the second world war.Most people would probably think there would have been a sharp dive in the stock market in September
1939 with the invasion of Poland, or after the bombing of Pearl Harbor in December 1941
Yet as you can see from the following chart of the Dow Jones Industrial Average, that is not what happened.The market instead bottomed much
earlier, in 1938, when Hitler annexed Austria as part of his Anschluss plan to reunite all of the German-speaking people in Europe
This was the first concrete signal of the build-up of a global war.Until the fall of France in the spring of 1942, markets remained
extremely complacent about the ongoing armed conflict
In fact, after bottoming again in 1942, the market began a bull run well before the end of the war.This possibly reflected the assumption
that the Allies were starting to get their act together
With the full-force intervention of the US towards the end of that year, winning the war was starting to look like a concrete
possibility.The events of the second world war show a key characteristic of financial markets: they react abruptly only to unexpected
events, while largely expected outbreaks are priced in (already factored into valuations) well in advance.So, for example, the 9/11 attack
triggered a violent reaction on financial markets, but the largely anticipated military occupations of Afghanistan and Iraq were largely
ignored.This possibly relates to the very nature of financial markets
Investors hate uncertainty more than anything, and there are few situations more uncertain than the threat of a war
When an armed conflict begins, however, to some extent uncertainty resolves and capital is reallocated.Ukraine and the markets These
observations can perhaps help to explain the complacency of international financial markets in response to Russia's announcement that it
defend them from Kiev.The S-P 500, major European stock markets and the VIX (which measures of market volatility) barely moved on a daily
On the other hand, the Russian stock market index fell by about 10 per cent.This could mean that international capital markets have already
been pricing in the risks of (a minor) conflict with Russia as part of the slide in stock prices over the past couple of months.The view
could be that as serious as this escalation could be, it is unlikely to have a material impact on US, EU or UK economic fundamentals or
If so, given the strategic importance of Russia as a net exporter of natural gas and oil, especially to the EU, this assumption might be
questionable at the very least.Meanwhile, the drop in the Russian stock market might reflect a belief that western sanctions will primarily
affect the Russian economy
Of course, there is the possibility of contagion effects across countries, especially Russia's neighbours, but these are hard to quantify
as they depend on the exposure of other countries to the Russian economy.Either way, markets have been conditioned not to overreact to
largely anticipated political and geopolitical shocks
Yet bear in mind that Russian gas pipelines feed many parts of Europe
cent.If Russia were to shut off the gas spigot, or have its oil infrastructure damaged, we could easily see a bigger spike in the price of
these resources, which would feed into already high inflation
Interruptions to the ports around the Black and Baltic seas could also exacerbate continuing disruptions to the global supply chain, which
could affect both European and UK recovery from the pandemic in the short-term.In other words, while market complacency might have a
rationale, it should be taken with the proverbial grain of salt
And all this is under the assumption that an eventual escalation in Ukraine should be limited to the Donbas area
Unfortunately, that could be a case of wishful thinking.
