Why inflation matters more than war

Nuclear war isn't the kind of risk that investors can usefully take into account when building a portfolio. Inflation and stagflation, however, are.

Ukrainian soldiers near a bombed-out school building
The invasion of Ukraine is horrifying – but it’s unlikely to move markets in the medium term
(Image credit: © REUTERS / Alamy)

“Buy on the sound of cannons” is a famous investment adage, but it’s not well supported by history, says Stefan Hofrichter of Allianz Global Investors. Yes, a look back at 13 geopolitical crises, starting with the Cuban missile crisis in 1962, shows that stocks have on average tended to do better after the onset of a global crisis and safe-haven assets have tended to do worse. But that average disguises a lot of variation.

“There have been times when markets bounced back emphatically and times when they haven’t.” Overall, “non-crisis-related factors were the biggest drivers of performance” in each case – such as the end of a US recession (the Iraq War in 1991), or the onset of a financial crisis (the invasion of Georgia in 2008). “Investors should make their decisions to buy or sell based on the health of the overall economy and the outlook for industries and earnings.”

What we can value – and what we can’t

There’s certainly no point in trying to price in worst-case scenarios, says Peter Berezin of BCA Research. The likelihood of nuclear war may now be higher than it was, which is discomforting, but that’s not the kind of risk that one can usefully take into account when building a portfolio. Thus it’s logically consistent to say: “The risk of Armageddon has risen dramatically. Stay bullish on stocks”.

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Still, even setting aside existential risks, “the world economy is facing a triple shock”, says asset manager Carmignac. “The uncertainty caused by the collapse of the post-Cold War geopolitical order, along with the risk of further escalation” is just one threat. Another is disruption to international trade, especially in commodities, such as embargoes and export controls. The third is “a financial shock, with potential defaults by Russian and Ukranian entities, and contagion risks to other countries”. Thus the world faces a growing risk of stagflation – “an economic slowdown coupled with high inflation”.

A most dangerous year

Conditions are certainly starting to look reminiscent of the 1970s, say Christian Keller, Rahul Bajoria and Akash Utsav at Barclays. Oil has topped $120 per barrel. The change is not as big in percentage terms as the oil embargo of 1973-1974, but natural gas – which is far more important to the economy today than it was five decades ago – has increased even more, “implying a massive energy-price shock”. Note too that “the ongoing price surge extends beyond energy into industrial metals, fertiliser and grains, which have all soared this week”. This bodes especially poorly for growth in Europe and much of Asia, while Latin America may be less affected since “the region gains most from the global commodity boom”.

Hence “this could turn out to be one of the most dangerous years for stock investors of the current bull market”, says Ed Yardeni of Yardeni Research. The US S&P 500 has held up “remarkably well” – it’s down 10% since the start of the year, better than most countries – but is likely to end the year lower. Investors should favour energy as a hedge against inflation and financials as a hedge against rising interest rates.