Kyiv residents flee the city as Russia launches first attacks
The West’s worst fears were confirmed this morning as Russia invaded Ukraine by land, air and sea, setting in motion a war that could be Europe’s largest conflict in decades.
On Wednesday, Wall Street’s major indexes ended sharply lower and extended their recent rout this morning.
The Dow and Nasdaq fell for the fifth straight day, while the S&P fell further into correction territory.
|*Stock data as of 9.43am EST 24/02/2022|
While market uncertainty had been firmly fixed on the Feds ability to fight inflation, war has now been added to the mix, accelerating the current sell-off.
This uncertainty has led to some dramatic price fluctuations as stocks violently whipsaw.
We have seen mega-cap names trade like penny stocks, as the apparent lack of euphoric outlook continues to bring the valuations of many of these names firmly into focus.
It appears that valuations actually do matter, and growth at any price isn’t a flawless investing strategy. Who would have thought?
War and Your Portfolio
The truth is, the pending geopolitical events are impossible to predict with certainty. As always, the most practical form of defence against these events is diversification across multiple asset classes, Market-cap sizes, regions and sectors.
With that said, it helps to analyze how similar past events have impacted markets.
While international conflict is tragic for all involved, it does not guarantee economic ruin. For example:
- During the Korean War (1950 to 1953), U.S. stocks fell at first, then recovered as normality resumed, rising roughly 15%.
- During the Vietnam War (1965 to 1973), the stock market grew by 43% as industries in the U.S. rebounded from the initial impact and began rebuilding.
- In both Gulf Wars (1990 and 2003), the market fell 10% initially but had recovered within a year.
Market corrections are also nothing new. Remember, stock market losses are a regular occurrence. Since 1950, the S&P 500 has had an average drawdown from peak to trough of 13.6% over a calendar year. And yet, markets have continued to grind higher over time.
Even during the S&P 500’s the nearly 11-year bull run from March 2009 to February 2020, the S&P 500 witnessed five corrections, according to CFRA. The pullbacks were prompted by concerns about everything from interest rates to trade wars to a European debt crisis.
The volatility you get from stocks is the prices you pay for the high returns they offer. It’s not free.
Winners and Losers
Like everything in life, there will be winners and losers. As callous as it may seem to highlight the benefactors or war, there is little room for emotion in investing. Looking at the market from an entirely unemotional lens, separate from the tragedy and turmoil of war, is an essential part of the process.
Defence stocks, commodities, especially oil, precious metal such as Gold will likely move higher while growth and transport stocks are likely to be negatively impacted over the short term.
For now, all eyes will be on oil movements. Russia’s outsized role as an oil and gas exporter makes this an area of extreme focus, given the inflationary impact that rising oil prices will have on the broader economy.
Russia provides 10% of the world’s and 50% of the EU’s energy. Although Biden has stated that he’d use “every tool at our disposal” to limit the conflict’s effects on US gas prices, prices could move higher and send already soaring energy prices higher.
It’s Not All Bad News
It’s important to highlight that earnings growth has continued over the quarter.
Despite the volatility, Q4 earnings reports have been broadly positive, with 77% of S&P 500 companies reporting a positive EPS surprise and 78% of S&P 500 companies have reported a positive revenue surprise.
Simply put, despite the falling stock prices, the companies that make up these stock market indexes are now more profitable than ever.
As well as record earnings, valuation metrics are contracting, GDP is at an all-time high and continues to grow while company margins continue to widen.
If the Fundamental of these Businesses are Strong, Why is Everything in the Red?
Ultimately the stock market is a forward-looking machine.
The market doesn’t care about what has happened nearly as much as it cares about what will happen.
As war looms and inflation lingers, investor uncertainty continues to build.
The current uncertainty in Europe has compounded the market’s inflation and interest rate worries.
As a result, the endless growth narrative that pushed many growth names to record valuations is being re-examined.
The immense expectation placed on these high-growth names following the onset of the pandemic was simply unsustainable. The market is now re-rating these stocks to account for the more realistic growth outlook given the current conditions.
Returning to Normal
Many of the growth names that have seen considerable declines have now been re-rated towards more respectable metrics without significant disruption to the broader market.
Facebook, Netflix, Shopify, PayPal, Zoom and Square have lost more than $1.1 trillion in market cap from their peaks seen in 2021.
Yes, it has been particularly painful if you’re holding these individual names, but the S&P has managed to eliminate much of the excess without recording significant declines in the overall index.
The recent drawdown across many of these high-profile growth names now leaves the overall market in a much healthier position from a valuation standpoint.
For example, the forward 12-month P/E ratio for the S&P 500 is currently 19.1. This is below the 19.5 times forward earnings recorded prior to the pandemic.
While geopolitical events may weigh on markets over the immediate term, recent pullbacks have helped to strip the pandemic exuberance out of the market.
As earnings continue to rise, these lower valuation metrics offer a more attractive entry point for buyers waiting on the sidelines. There are now high-quality stocks at 52 weeks lows that are arguably ‘cheap.’
But of course, it is not that easy. These stocks could get even ‘cheaper’ as the Ukraine situation unfolds.
Don’t presume rational behavior in moments of heightened uncertainty.
Next Steps for Investors
Through the clarity of hindsight, all past declines look like opportunities but saying ‘I’ll be greedy when others are fearful” is easier said than done.
When the chips are down and war is looming, it’s suddenly much harder to confidently swing for the fences.
Unfortunately, it is impossible to know precisely when the current negative sentiment will be reversed, especially with Putin at the helm.
History has shown that military attacks typically result in initial sharp market drawdowns followed by a rebound but attempting to pinpoint this reversal is a dangerous game.
From here, investors need to ensure they focus on their medium to long-term view. Concentrating on your individual investment goals will help strip out the short-term noise from the market.
Focus on the earnings, not the rest. Earnings ultimately drive market returns over the long term.
History is Just One Damn Thing After Another
There will always be uncertainty. There will always be a seemingly justifiable reason to sell, but history has shown that markets prevail.
This is perfectly summarised by Morgan Housel and Warren Buffet.
Over the long term, the stock market news will be good. In the 20th century, the United States endured two world wars and other traumatic and expensive military conflicts; the Depression; a dozen or so recessions and financial panics; oil shocks; a flu epidemic; and the resignation of a disgraced president.
Yet the Dow rose from 66 to 11,497.
– Warren Buffet