‘Buy the dip’ mantra is complacent as Putin redraws the map of Europe
When London’s Gresham Life Assurance Company completed its luxurious Art Nouveau headquarters in Budapest in 1907, it clearly did not expect the world it was designed for to crumble in just a few mid-century years. bloodshed of a world war, a pandemic, protectionism and a financial crash.
much has been written about the impact of Russia’s invasion of Ukraine on the global economy and markets – and the assessment has been that growth will slow just a little bit in Europe and hardly at all in America ; that there will be a temporary spike in inflation and that stock markets will fall before recovering.
At first, that seemed to be the way it was. Just 48 hours after Vladimir Putin’s troops began the biggest military incursion into Europe in 70 years, the benchmark US stock index, the S&P500, is up 6% from its invasion lows.
That’s fast by historical standards, as portfolio manager Jens Nysted’s research shows that a major geopolitical shock leads to a median loss of 3.4% on the S&P500 and once that bottom is hit, the market recovers. his losses in five days.
It sounds like the kind of bet Gresham might have made in 1914 in a highly globalized world of mobile and abundant capital that was strikingly similar to ours. Inflation expectations were firmly anchored by the gold standard.
Investors and traders in financial markets are now conditioned to “buy the dip”, which we have seen repeatedly throughout the Covid pandemic. And that in itself is dangerous because it is self-reinforcing and triggers herd behavior.
In 1914, investors remained indifferent until World War I broke out, according to historian Niall Ferguson.
“Apart from an upward movement in Austrian bond yields, there were no significant changes in the bond market, money market or foreign exchange markets until the last week before the outbreak of war” , Ferguson wrote in an article examining past crises.
In other words, markets don’t see it all, nor discount shocks of the kind we’re seeing in Ukraine, as we discovered when financial sanctions against Russia were tightened over the weekend, plunging stocks and soaring oil prices. . Market movements should not be confused with the reality of events shaping our world.
According to Ferguson, any investor reckless enough to hold UK government bonds would have seen real yields fall by 46% in 1920, while UK equity yields fell by 27%.
Of course, things were much worse for those, like Gresham in Budapest, who held assets in the Austro-Hungarian Empire, in Germany or in Russia where the revolution swept away the Communists in power with a default on debts owed to financial.
But no geopolitical crisis is like another, as those who insist on buying the dip seem to believe. Putin clearly had bigger ambitions than creating small lackey states, as he did in Georgia in 2008 and Ukraine in 2014, but our risk assessment has not changed.
If you had assumed, for example, that the way to trade in World War II was the way to make money in World War I, then, Ferguson notes, you would have lost.
UK stocks returned 50% from 1938 to 1948, beating the US market’s 25%, while in bond markets you saw returns of 11% and 6%, respectively.
“Past experience would have led any reasonable asset allocator to overweight US stocks in 1939. The current knowledge that London was within reach of German bombers, while New York was not, only reinforced the lesson of history,” he wrote.
How could this play out in such a way as to blow up this “buy the dip” scenario? One is when oil prices continue to rise and economies roll back in an era of high and sustained inflation. It would shock markets at a time when governments have already maxed out their balance sheets battling Covid.
Putin may find he has little to lose by increasing pressure on the three ex-Soviet Baltic states that are members of the EU and NATO. Instead of a peaceful trading bloc of 450 million people, the EU may have to become more militarized. Another is that an angry and resentful Russia is turning against Putin and we have an unstable nuclear state on the borders of Europe.
Both Ukraine and Russia are major grain exporters to Arab countries like Egypt and Libya. Rising energy and food prices put pressure on the budgets of the poorest countries through subsidies. The food price shock can also cause popular unrest, as was the case during the Arab Spring.
It seems habit forms easily in the financial markets and they have acquired immunity to shocks, especially ones that seem cyclical like the regular provocations served up by North Korea, or by Putin until today. .
As for the Gresham Palace, it is now a Four Seasons hotel. It opened in 2004, a century after it was designed and 90 years after a “blow heard around the world” sparked World War I.
The building was at one time a barracks during the communist regime in Hungary and there is even an Irish connection as Quinlan Private restored it to its former glory.