In response to the twin pressures of a potential rate hike from the Federal Reserve, coupled with the increased threat of conflict in Ukraine, global markets this week experienced high volatility compared to the historical average. US stocks opened the week sharply down dragging the major indexes into over 10% negative territory for 2022 before a late rally. On Tuesday morning the market bears prompted a similar sell-off before eventually rebounding. The nervous nellie nature of the market meant the peaks were especially peaky and valleys particularly deep, which in market-speak is known as volatility. Expected volatility is most commonly measured by the VIX index. 

The VIX index is determined by a sampling of options traded on the S&P 500 (An index of the largest 500 US companies). By looking at option pricing the VIX index measures confidence in the S&P 500 which is a reflection of the overall market expectations. On Monday the VIX index measured a shocking 38, a level not seen since the early days of the pandemic. Tuesday the VIX index opened at 35 and as of Wednesday morning was trading just below 30. This is significant because the long-term average of the VIX hovers in the mid-teens. In essence, the VIX index is like looking at a collection of insurance premiums for the stock market, just as a home insurance company might look at insurance premiums for a coastal property. If there is a hurricane offshore, insurance premiums are going to go up. Looking at the VIX index this week, investors signaled that a storm was brewing. 

 As we saw this week geopolitical instability or the threat of war, often is correlated with market volatility. Surprisingly, the actual break out of conflict itself does not historically coincide with poor market performance. This is known as the war puzzle. In the run-up to conflict, we see volatility in global markets. This is understandable. In the case of Ukraine, armed conflict could provide a serious threat to energy production and supply chains. Europe, specifically Germany, is largely dependent on natural gas from Russia to meet their energy needs. Russia is one of the world’s largest producers of oil and natural gas as well as precious metals like Palladium. Even if a ‘hot war’ doesn’t physically interrupt the supply chain it is likely that imposed sanctions, as threatened by the US government, would impact global prices. Russia would almost certainly respond to economic sanctions, providing another point of uncertainty impacting global markets. 

Paradoxically, the uncertainty of pre-crisis activities often stabilizes during the onset of the conflict itself. Take two seminal national security incidents that rocked the markets- the attack on Pearl Harbor and 9/11. The S&P 500 drawdown after the attacks on Pearl Harbor was over 19.8%. It took close to 300 days for the market to recover, but over the full course of WWII, the Dow Jones Industrial average actually increased over 50%. Similarly, on 9/11, the stock market suffered (the then) the greatest single-day point loss in its history. By the end of the next week, the Dow had dropped over 16 percentage points, the S&P 11.6%, and the overall loss was estimated to be over $1.6 trillion. This precipitous drop was actually preceded by the dot com bubble burst, meaning the market was already hurting when the attacks occurred. Similar to the aftermath of WWII, those losses were not sustained, and the market recovered to make new highs. Over the course of the next two wars in Iraq and Afghanistan, the market increased four-fold (despite the 2008 economic crisis and the global pandemic). This pattern holds for significant national security incidents over the last 75 years as outlined in the below table. 

So how do we account for this enigma of war where pre-war markets remain volatile, but subsequently stabilize when the shooting starts? First and foremost it is important to remember that the stock market is acerbic mostly to uncertainty. Counterintuitive as it may sound, the outbreak of war, as opposed to the threat of war actually creates a degree of certainty. War is not the sole determinant of market volatility, but it is the factor most directly related to the military community. Some of the key insights to market behavior lie in the initial volatility in pre-crisis trading. In a sense, the volatility of pre-crisis activity is the market “pricing in” the cost of potential conflict. This behavior is not limited to the stock market. You can see the change in the prices of other significant economic indicators such as the price of US crude oil. During this week of trading US crude and natural gas commodities prices increased. Brent Crude and West Texas Intermediate Crude spiked on news of tensions. This is a direct manifestation of supply and demand anticipating a decreased availability of Russian oil in event of a shooting war. 

So, while it is impossible to completely predict how all the pieces of the war puzzle fit together, the question remains, how does the average investor grapple with these macro forces influencing the market? Sean Bonner, CEO of Guild, an investing platform dedicated to the military community, advises long-term investors to stick to their long-term strategies. “The crisis in Ukraine is a looming threat to the market that is much harder to predict. A sad but true fact is that war is usually good for the American economy. Increased government spending with a clear direction of increasing the production of goods and services creates jobs and increases economic activity.  The stock market is always digesting and assessing risk. A true and common saying on Wall Street is, ‘The stock market climbs a wall of worry.’ but if the crisis with Russia really goes hot that wall may see some big cracks.” 

So while the commencement of hostilities might actually be good news for investors after the roller coaster of this week, it is important to remember the other wall of worry that lies behind the gates of Fort Bragg, Ramstein Air Force Base, Naval Station Rota, and the other bases that house those who could be sent to the frontlines. The assets at risk in those communities are far greater than any portfolio. As the ominous and familiar drums of war begin their soft beat, Wall Street sleeps more soundly under the blanket of those who have the most to lose.