War: The Best Time to Buy Stocks

No one expected 2022 to be an easy year for the stock markets... after two consecutive years of spectacular gains, a runaway rally was highly unlikely this year.

Indian stock markets had a stellar run in 2021. The benchmark Nifty 50 index and the S&P BSE Sensex gained 24% and 22%, respectively.

However, the year 2022 started off on a weak note as investors braced for a scenario of interest rate hikes, high inflation, and lesser liquidity.

And amid this combination of an already-fragile situation in interest rates/inflation, now the Russia-Ukraine war has added to investors' worries.

Dalal Street witnessed a steep rise in volatility on February 24 as the invasion of Ukraine by Russia spooked market participants.

The volatility gauge, India VIX, surged more than 30% in a single day.

India VIX, which is also called the fear index, that measures expected volatility in the market, jumped up to 33.97 intraday before settling at 31.98, the highest closing level since 17 June 2020, up 30.31% over the previous close.

The big question: Will the geopolitical crisis have a prolonged impact on Indian stocks?

Let us first try and gauge the long-term impact on stocks based on past history.

How the Market reacts to War

War is never a pleasant reality to any degree for anyone involved. However, as investors, we need to protect our money regardless of the situation.

And as savvy investors, we should look at opportunities in times of such crisis.

As seen over the past week, the market has fluctuated wildly in almost daily reactions to the conflict in Ukraine.

On February 24^th, the NIFTY50 was down by 815 points, a drop of 4.8% in a day. Over the next two days, the index had recouped close to 3.35% of its losses.

So, it's been up, it's been down - and it seems to react to every message and headline we read.

But let us take a step back and look at a longer-term impact based on past data of how the market reacted during times of war and crisis.

After the 9/11 attack in America, the NIFTY crashed by 15% over the next few days. But over the next 3 months, the index was up 24% and had gained 30% in 6 months since the twin tower attack.

The Iraq-Kuwait war of 1990-91 triggered a sharp correction in markets, and oil prices doubled. The markets were down by 13% but over the next 6 months had recovered by 16%.

The Russia Afghanistan war had no significant impact on the Indian stock market.

The Lehman brother collapse of 2008 led to the NIFTY index crashing nearly 40% over a 21-day period. Many banks around the world incurred large losses and relied on government support to avoid bankruptcy.

Despite all this turmoil, NIFTY was up over a 100% higher from its lows over the next 14 months.

Most recently, the NIFTY plunged over 30% with the lockdowns imposed due to the pandemic of 2020. However, the markets have recovered sharply and gone on to make new highs since then.

Notice a trend here? War and conflict bring sudden crashes but usually, the recovery is relatively steady and predictable.

Let's take a look at how the Dow Jones reacted to geopolitical events and crisis over the last 80 years:

Crisis	Year	Days	↓ Change%	3 Months	1 Year
Pearl Harbour Attack	1941	4	-6.5	-2.9	5.4
North Korea invades South Korea	1950	20	-12	15.3	26.3
Cuban Missile Crisis	1962	8	1.1	17.1	30.4
JFK Assassination	1963	1	-2.9	12.4	24
US Bombs Cambodia	1970	27	-14.4	20.3	43.7
Russia Afghanistan War	1979	22	-2.2	-4	21
1987 Stock Market Crash	1987	17	-34.2	11.4	24.2
Iraq’s Invasion of Kuwait	1990	21	-13.3	2.3	22.4
Asian Crisis	1997	20	-12.4	10.5	16.9
9/11 Terrorist Attacks on US	2001	5	-16	24.4	-1
Global Financial Crisis	2008	40	-33	-1.1	40.2
North Korea Missile Crisis	2017	1	-0.6	7.3	16.6
COVID 19	2020	23	-34.8	44	78

Source: Equitymaster

History tells us periods of uncertainty like we're seeing now are usually when stocks suffer the most.

In 2015, the Swiss Finance Institute studied a number of large international military conflicts since World War II in their paper, "The War Puzzle: Contradictory Effects of International Conflicts on Stock Markets"

It found that in cases when there is a pre-war phase, an increase in the war likelihood tends to decrease stock prices, but the ultimate outbreak of a war increases them.

However, in cases when a war starts as a surprise, the outbreak of a war decreases stock prices. They called this phenomenon "the war puzzle" and said there is no clear explanation why stocks increase significantly once war breaks out after a prelude.

The implication from this data is that a war or a crisis and the effect it has on the market should be viewed as a buying opportunity for quality stocks and investments. Most of the time, the market simply shrugs it off.

History is full of examples where investors benefitted from contrarian investing. As the famous saying goes - buy when there's blood on the streets.

Buy Now or Wait it Out?

The reason why the current geopolitical tension is so crucial, and why we're seeing so much volatility is because the threat of armed conflict coincides with one of the highest threats of inflation in recent times.

War and Rising Oil Prices

Currently, the markets have two major concerns- escalation of the Russia-Ukraine conflict into a full-blown war involving other countries and a resulting increase in oil prices which would send inflation levels even higher.

A quick end to the conflict and as Washington and Tehran approach the finish line in talks aimed at lifting curbs on Iran's oil exports, could prove in hindsight to be a good opportunity for medium-term investors.

There will be no direct impact of the Russia-Ukraine crisis on India in terms of bilateral trade.

India imports only 2% of its crude oil from Russia, making it less vulnerable to supply disruption. However, the country is susceptible to the global price rise.Rising crude oil prices will be challenge for companies already grappling with increasing input costs.

Any further hike in raw material and energy prices may put further pressure on the margins of domestic companies going ahead.

Higher crude oil prices are major headwinds for a couple of sectors including aviation, paint, tyres and oil marketing companies.

On the other hand, higher oil prices would put pressure on the rupee which could be positive for export-oriented sectors like IT and pharmaceuticals.

It is assumed that a rise in crude oil prices will adversely impact the stock market. But is it really true?

Surprisingly, the correlation between crude oil prices and the Nifty has been positive over the last two decades. In the past 20 years, the benchmark Nifty has rallied in six out of the nine times when crude prices ran up.

Federal Reserve Rate Hikes

At the moment, the bigger risk to the equity markets continue to remain the Federal Reserve increasing interest rates and tightening of money supply.

The markets have been playing a guessing game this year, trying to figure out just how far the central bank will go.

But even with the ongoing conflict, most economic analysts expect the Federal Reserve to start raising interest rates this month and not slow down until well into 2023.

However, markets across the globe have factored in these anticipated rate hikes which is reflected in the market correction since the beginning of the year.

Interestingly, the historical link between interest rate change and its implication on market returns is not so clear-cut.

Year	US 10 Yr Avg Yield	NIFTY Return %
2013	2.35	5.93
2014	2.54	31.44
2015	2.14	-4.08
2016	1.84	2.8
2017	2.33	28.75
2018	2.91	4.09
2019	2.14	11.53
2020	0.89	14.77
2021	1.45	23.8

Source: Equitymaster

Supply Chain Inflation

Experts believe that the supply chain disruption is expected to normalise this year which would help in cooling off the supply driven inflation over the next few quarters.

With normalisation of growth, commodity prices are likely to cool.

While large companies have already managed to pass on high input costs successfully to consumers, smaller companies have been struggling.

Smaller companies which lack pricing power, are unable to pass on the increase in input costs to consumers, crimping their profitability.

Hence, large companies having the ability to manage costs have seen a rising market share and this is expected to continue going forward.

And investors like businesses that can pass on costs to consumers.

Stronger companies will emerge stronger while weaker companies will falter.

It would be prudent for investors going forward to buy stocks of large high-quality companies anchored by robust balance sheets and high cash-flow generation and resist the strong temptation for investing in new age stocks burning cash.

To Wrap it all up...

The markets have been through wars, coups, recessions, pandemics and multiple geopolitical crisis in the past.

In the last 5 years, India has witnessed Demonetisation, US-China Trade Wars, NBFC crisis, the India-China skirmish, banking crisis and recently the pandemic.

In the same 5-year period, the NIFTY is up by over 80%.

If the past has taught us anything, it's that you have to try as best as possible to stick to your long-term view and not get caught up in the headlines. The markets seem to always bounce back.

As the Russia- Ukraine conflict is set to continue, investors must track other significant developments including the rate hikes and inflation figures and base their investment decisions on the fundamental and economic outlook for India in the long term.

2022 was always going to be a year of selective stock picking. Investors must single out companies and industries best positioned to navigate supply-chain disruptions and inflation headwinds.

Let's conclude this article with the following story told by veteran trader Art Cashin about the advice he received from a seasoned trader during the Cuban Missile Crisis of 1962 as he was worried about the impact on stocks:

Jack said - "Look kid, if you hear the missiles are flying, you buy them. You don't sell them."

"You buy them?" I said, somewhat puzzled.

"Sure, you buy them!" said Jack. "Cause if you're wrong, the trade will never clear. We'll all be dead."

Happy Investing!

Disclaimer: This article is for information purposes only. It is not a stock recommendation and should not be treated as such. Learn more about our recommendation services here...