The Impact of the Russian-Ukrainian Conflict on the Stock Market

Is there a relationship between geopolitics and capital markets? Those who invest in the stock market can respond by the affirmative that there is a relationship, indeed. The Russian-Ukrainian conflict clearly epitomizes this relationship. The stock market today is low. The Standards and Poor’s 500 Index is performing below its conventional rate as we can see in figure 1.

Figure 1. Source: MarketWatch

The current low performances of the stock market are linked to the macroeconomic issues of the Russo-Ukrainian conflict. This conflict is currently creating intense volatility in the financial market and incentivizes investors to act irrationally. Russia is the largest producer of natural gas in the world. Europe—and particularly countries such as the Baltic states and Poland—would be likely to experience more negative impacts than would countries that depend less on Russia for energy. Western Europe, particularly Germany, also has no easy alternative source of energy to replace Russian natural gas. The European Union has said that it would impose economic sanctions on Russia if the latter had opted to use military force to solve this conflict. Russia could react to these sanctions by simply restricting its gas exports. This will subsequently impact the energy industry worldwide. According to Dirk Hofschire, who is the Senior Vice President of Fidelity Asset Allocation Research Team, a Russian military action against Ukraine also poses a relatively short-term risk to energy prices. "It could drive up prices of oil, natural gas, and other commodities at a time when inflation is already a problem."

Figure 2. Source: Wall Street Journal

For the retail investors (most of us investing in the stock market), this conflict will add supplementary inflationary pressures due to high energy prices. Consequently, investors will develop a sentiment of distrust towards the Russian capital market. According to J.P. Morgan, a supply disruption could elicit a price rally in European natural gas prices similar to what occurred in late December. This would also impact the price of oil, as countries would likely switch away from natural gas: “Any disruptions to oil flows from Russia in a context of low spare capacity in other regions could easily send oil prices to $120 bbl. A halving of Russian oil exports would likely push the Brent oil price to $150 bbl.”

According to a Barclays analyst, “Russia credit tends to underperform broader markets as geopolitical tensions build up and around sanction announcements. However, at least from a sovereign credit perspective, periods of underperformance have often been followed by a relatively swift rebound.” The sanctions imposed on Russia will not have any substantial long-term consequences we most of the developed nations rely on Russia for its natural gas and oil. For retail investors who have been mostly investing in the energy sector, this conflict is a signal that they should consider hedging their investments. Diversification becomes imperative in order to avoid any unforeseen shock in the stock market from that particular sector if , and only if, one had a substantial portion of his/her investment in that sector.