Welcome to Finance and Fury. I hope you are all doing well and safe at the moment – I know a lot of people in QLD and NSW have lost their homes and my thoughts go out to you – where we live is currently cut off – we are fortunate though – no flooding in the house – there might be a bit of background noise as helicopters are dropping supplies in the region –

  1. A weather event like this is one of those awful events that happens – hard to really prepare for – such as a war breaking out –
  2. In this episode – I want to look at the core reasons as to why markets fall, explore the current geopolitical events, particularly the Russia/Ukraine conflict to determine if this is a genuine cause of concern for markets – then look at if this is a buying opportunity through an over reaction from markets
    1. Seems a bit trivial when lives are being lost in war and flooding – but Ill leave it to others to discuss the moral and political sides to this conflict – as we will focus on the financial markets reactions


Like rain falling – What is causing equity markets to fall?

  1. The answer is obvious – A higher level of sales that purchases of an investment on the share market –
    1. Historically I would have said people selling – or buying – but the majority of share trades are now automated – a few years ago this reached 80% of trade volumes – the robots are now in charge
    2. This is part of the reason we saw a record-breaking flash crash back in first half of 2020 – then another record-breaking recovery – in terms of time – When computers are in charge, they make decisions quickly and follow a trend based around available information – but this does offer opportunity – computers can have the tendency to oversell and over purchase – just like humans
    3. Computers are programmed by people – even self-learning technology – like AI is programmed to learn around criteria set by those that program it – then let it loose
  2. So what is the available information that these algorithms and markets at large are reacting to?
    1. At the current state of the market cycle – it is a combination of high inflation readings, concerns about central banks increasing interest rates and escalating tensions between Russia and Ukraine – These three factors combined are causing equity markets to decline.
      1. In the United States, inflation is running at 7.5%—the highest level in 40 years—and markets now expect the Fed to lift interest rates six times this year – Markets have currently priced in 4-5 price increases
        1. Inflation is everywhere – no country has escaped it – so interest rate increases across the globe are likely and have been priced in
      2. Amid the turbulence – it’s important to keep in mind that equity markets have climbed significantly since their March 2020 lows. Case-in-point: At its recent peak, the U.S. stock market had risen by 117%, while non-U.S. developed markets had gained 78% on average.
  • These gains had been accompanied by signs of investor exuberance – the over purchase of risky investments – so a correction was always expected
  1. Given all this, it’s not too surprising that markets have weakened admits the macroeconomic concerns and geopolitical tensions – so a correction is warranted – But the Russia-Ukraine conflict is really a known unknown – The whole thing is a mess

Recently – Market volatility has increased as Russia/Ukraine conflict plays out.

  1. But is the drop in markets that occurred over concerns of WW3 breaking out – or what would have more or less occurred anyway – but just exacerbated by the news cycle?
  2. This is a heavy topic that does deserve a whole hour to explain the geopolitician history properly – complex issue that has hundreds of years of history –
    1. I don’t support any actions of war – in my perfect world no government would be large enough to action a war of this magnitude – All governments suck
    2. Russia has been under sanction since the Crimea incident of 2014 anyway – and any further sanctions, such as the limitation of sale of their gas supplies may hurt Russia’s economic output – but hurt Germany even more so – the EU is heavily dependent on natural gas
    3. sanctions on Russia including restrictions on Russian banks, foreign trading in Russian sovereign debt. Over the weekend it was announced Russia will be cut off from the SWIFT international payment network used by 11,000 banks in 200 countries. In addition, Germany has announced a halting of the start-up approval of the Nord Stream 2 gas pipeline which is intended to supply gas from Siberia to Europe via Germany.
    4. They are also currently under new sanction that block their central bank and their credit rating has been downgraded to junk –
      1. This downgrade would normally be a big deal – but if their central bank is under sanctions and their foreign exchange holding are barred from transactions with other nations – this is a major deal
      2. Could see the collapse of the Ruble making the economic output of Russian collapse –
  • The impact of the initial sanctions remains uncertain, and the fact they didn’t deter Russia from invading in the first place, raises questions about their efficacy
  1. The introduction of meaningful sanctions will require the West to accept significantly higher costs and potential spill over effects. A risk in banning Russia from using the SWIFT system is it increases the risk of politicising the platform and the use of alternative platforms like CIPS, China’s rival to SWIFT for the cross-border payments in yuan
  1. But the other issue is Economic – Russia is also looking to expedite the approval of a second natural gas pipeline, Nord-stream 2, between Russia and Germany – this would be through the Baltic sea and get around this NATO blockade and sanctions that they have faced since 2014
  2. You also have economic reasons – oil and gas supply infrastructure –
  3. In fact – most EU countries are heavily reliant on Russian energy – and Russia supplies 35% of Europe’s gas demand.
    1. – as an example, Germany relies on Russia for around 60% of gas supplies – so energy prices in the EU would rise – increasing the costs for most things along the way and they may face shortages
  4. The flow on issues could also devolve and spread throughout the world
    1. Further inflation impulse and risk to growth: – the Russia-Ukraine conflict adds to the complexity and concerns around inflation and the economic recovery. represents the largest area of arable land in Europe and is a key supplier of barley, wheat, potatoes, and sunflowers as well as being Europe’s largest producer of ammonia (a key fertiliser input), whilst Russia is a major source of energy. Together they produce 15- 20% of global output of main grains
    2. Russia and Ukraine make up about 1/3rd of the world wheat export market – so if there is nobody farming or sanctions on trade – the food prices may start to rise even more – when inflation on food is already high
    3. In addition – nitrogen is a key component in most fertilisers – but natural gas is needed for heat and part of the process to produce ammonia nitrate – so this may also increase food prices – but may not be noticeable for a while
    4. But there are major food producers who operate in Ukraine – like Nestle – the largest food producer has three plants in Ukraine which are being shut down – this could lead to food shortages further through the EU as well as Northern Africa
    5. There is also the question of how central banks can fight food and energy inflation? Traditional monetary policy tools tend to have little permanent sway over food and energy prices given their essential nature.
  5. Australia more insulated, Europe more exposed: Australia has relatively little direct economic and financial exposure to Russia and Ukraine. In 2020 Australia’s two way trade was only 0.2% of our total trade. It also has little direct exposure in terms of debt and equities. The greatest impact is likely to be felt indirectly through any impact on higher oil and petrol prices and over time, food prices if the situation becomes protracted.


So – getting to the major question: Is the level of the current market pullback warranted?

  1. It is important to remember – that if the current market decline over the past 2 months is purely due the news of Russia/Ukraine – Financial markets historically have recovered quickly from geopolitical events
    1. An obvious historical comparison – which was also the most significant in terms of market impact, is the Iraqi invasion of Kuwait in 1990 – Many of you listening may not have been alive – I was a mere infant barely able to walk – But the S&P 500 Index fell 1.1% on the day this occurred and would go on to decline by 16.9% over the course of 10 weeks – but then this just took six months to fully recover and then continue to climb
    2. I did an episode a while back on Wars and markets – where we went through the annualised returns in major conflict – as long as you nation wasn’t directly impacted – your market was ahead by the end of the calendar year – But this doesn’t meant that there wasn’t a decline in the short term
    3. The key takeaway here: Stock markets can move past geopolitical events relatively quickly and can provide a good buying opportunity
  2. This depends on what countries are fighting and the impact on the global economies – as an example – shares in the US jumped 2.3% when the U.S. invaded Iraq in 2003. The marketswere up 30% by the end of the year
    1. But this is a super power going to war with a smaller country – that didn’t have another super power backing it
  3. Historically, the main driver as to whether we see a correction (a fall of, say, 10% to 15%) in the longer term – i.e. more than a 12 month period – or even a mild bear market (with, say, a 20% decline that turns around relatively quickly) as opposed to a major bear market all comes down to whether there is a recession in the United States – If a war breaks out and geopolitical risks are high – then markets take a longer downturn in returns if the US is in a recession
    1. This is an interesting question – is the US in a recession – Based around the current numbers – which should always be taken with a grain of salt – the recession risks, at least for the next 12 to 18 months, look relatively low – there is low growth, higher unemployment – but the way recessions are measured the risk of an official recession is lower
    2. There is currently strong household and corporate balance sheets – which leave the US in positive positions to deliver at least on-trend to the economic growth predicted for the rest of 2022
    3. Even though the Fed is likely to begin lifting interest rates as soon as March, this has already been priced in by markets and hence, wouldn’t have an effect on pricing mechanics when this materialises.

Key watchpoints amid the current geopolitical events if you are thinking of investing

  1. In my view –
    1. Increases in interest rates will naturally tank markets – particularly those in higher growth shares – i.e. those that have not much in the way of cashflow of fair value
  2. When it comes to investing – It is always important to look at potential market opportunities through the lens of a market cycle, as well as valuations and market sentiment
    1. If this is just another geopolitical event – in the medium-term cycle (i.e. over a 3 year period) – valuation have improved slightly as markets correct themselves due to sentiment
    2. This makes sentiment the main watchpoint – computers trade on news – so if news if good they buy – But if you can get ahead of the news, and buy on the downside – does this held – in the long term – 10+ years – it should
  3. I would say that in the short term – the market is starting to look oversold – this is when compared to potential growth over the next 10 years
    1. In the next few months – there is a potential for some further sell offs of equities – resulting in a loss in processes across most major indices.

In summary – What to do from here – This is up to you – not financial advice – I am personally investing more at this time – when looking at timeframe of investment – now is better than 6 months ago due to the price level of assets – I am investing for the long term – 10+ years – if you are investing for the next year – better not to invest

  1. Whilst no two situations are the same, a key message for investors is geopolitical events tend to result in sharp sell offs, but also rebound quite quickly if economic growth is largely unaffected.
  2. If you are worried about further downturns – may not be best to invest – if you are willing to take a punt – now is a good time to slowly enter the market –
  3. DCA in my personal opinion is the best to capture both the downside and the upside

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