Geopolitical Conflicts and Financial Market Volatility

The actions of Russia leading up to and including its invasion of Ukraine on February 24 have resulted in more volatility in the financial markets around the globe, affecting stock prices, bond prices and the price of oil in particular. As a long-term investor, it is inevitable that geopolitical conflicts are a risk while investing, and we are once again reminded that it is somewhat normal and something we must still expect. Times like these are often when investors are rewarded when they stay disciplined and invested during the eventual recovery.

We cannot predict how the global stock market will perform in the immediate future, and we know this type of volatility can be distressing. We are not far removed from early 2020 when the onset of the coronavirus pandemic caused uncertainty and volatility. Markets compensate stockholders and bondholders for taking risk, and if investors in aggregate think that risk is elevated, then they should rationally demand more compensation. Lower prices mean higher expected returns long term, and so if investors are demanding higher compensation for investing, then prices should go lower. That could best describe the start of this year — investors demanding more future expected return for taking the risk of investing, and that happens through price adjustments. What the data shows and what we do know is that a long-term investor’s most effective mitigation of geopolitical risk is staying disciplined during times of uncertainty and investing in a globally diversified portfolio.

When considering the impact of conflicts similar in nature to what is happening on the ground in Ukraine, we see that geopolitical conflicts typically experience short-lived selloffs and that market recoveries can happen fairly quickly. We have looked at the returns of the S&P 500 Index following incidents of conflict or declarations of war — the chart below shows the 6-month, 1-year, and 3-year return periods following the date of those events. You can see that in most all time periods, the 6-month or 1-year return period made a recovery, and all 3-year return periods exhibited a positive return. The average return between the date of incident and the 6-month, 1-year, and 3-year periods following are 5%, 13% and 40%, respectively.

All returns shown are cumulative, not annualized. The starting date is the first day of the month during which the incident began or the month after, whichever produced the lower 6-month return. Returns are proxied by the S&P 500 Index. Indices are not available for direct investment and not indicative of any particular underlying investment. They serve as a useful proxy for overall market performance.

Focusing on the country of Russia in particular, we want to provide context for how much Russian stocks and bonds make up in a diversified portfolio. As a simple proxy for this within the Dimensional funds we use predominantly, we looked at the DFA World Core Equity Portfolio (DREIX) and DFA Global Core Plus Fixed Income Portfolio (DGCFX) funds, though these results are also consistent for our clients who own more than one Dimensional fund:

We put these in chart form to emphasize a point. Our philosophy of global diversification seeks to capture returns from thousands of companies around the world — offsetting weak performance in one country with stronger returns in another.

Certainly, unforeseen events and geopolitical conflicts of this nature are devastating when thinking about the human impact. We would be remiss in not acknowledging the humanitarian concerns, too. We recognize that such periods are never easy to live through. Our view of the world is shattered just a bit, with the forced recognition that global peace and prosperity have never been assured. In these situations, the thing you can control is your own behavior and realize that making a decision that does not conform to your long-term plan will often lead to poor outcomes.

Investors who do not remain disciplined too often miss out on the eventual portfolio recovery. Long-term investors position their portfolios for success by rebalancing to capture recoveries and adhering to their written financial plan.