Geopolitical events and financial markets

Normally investors do not have to lie awake over political turmoil. On the contrary, if you go through the list of past geopolitical events and their impact on the market, you will see that they were almost always a reason to buy stocks. So, there is no reason to scare investors unnecessarily with geopolitical analysis. You must look at the broader macroeconomic context. It is always more relevant than the event itself.

Some historical perspective: the 1973 Yom Kippur War

In that respect, there is a problem with the Russian-Ukrainian conflict, because it is different from the norm. A rare exception to the rule that geopolitical turmoil is a buying opportunity was the 1973 Yom Kippur War between Israel and some Arab countries. That war took place in the middle of an inflationary context. In the US, the government was driving inflation with 1960s social programs and spending on the Vietnam War. The US central bank was raising interest rates. And then came the Yom Kippur war and the subsequent oil embargo by the Arab countries, which drove up the price of oil, putting a cherry on top of the cake of existing inflation. It was a matter of bad timing.

Evolution of oil prices and Fed funds rate (1970-2022).

Source: Bloomberg.

What about today (update November 2022)

Today we have a similar situation due to the global inflationary environment. If Russia effectively invades hard, the market impact would be serious, with a solid correction for stock markets and higher oil prices. Financial markets are not taking this into account enough. 10-year U.S. government paper is considered the ultimate haven, but the yield on that paper does not show that investors are very concerned. If a Russian invasion does occur, gold and wheat are an interesting hedge. Both did well in the 2014 Russian invasion of Crimea.

Evolution of the US 10-year interest rate.

Source: investing.com.

Link with market efficiency

This situation links to market efficiency in a semi-strong form (public news). Even with the information publicly available, the markets are not pricing in or correcting in the risk or consequences of a hard invasion of Russia into the Crimea. A hard invasion could potentially induce a lot of uncertainty and volatility into the market, with Russia’s strong foothold in the international energy market. Potential embargos and supply shortages could have a major impact on the prices and induce a hefty inflation increase. This is currently not priced in the markets and thus shows that the market was not efficient in the semi-strong form.

Approaches to investment

In this article, Henri VANDECASTEELE (ESSEC Business School, Master in Strategy & Management of International Business (SMIB), 2021-2022) explains the two main approaches to investment: fundamental analysis and technical analysis.

Fundamental analysis

Fundamental analysis (FA) is a way of determining the fundamental value of a securities by looking at linked economic and financial elements. Fundamental analysts look at everything that might impact the value of a security, from macroeconomic issues like the state of the economy and industry circumstances to microeconomic elements like management performance. All stock analysis attempts to evaluate if a security’s value in the larger market is right. Fundamental research is often conducted from a macro to micro viewpoint in order to find assets that the market has not valued appropriately. To get at a fair market valuation for the stock, analysts often look at the overall status of the economy, then the strength of the specific industry, before focusing on individual business performance.

Fundamental analysis evaluates the value of a stock or any other form of investment using publicly available data. An investor, for example, might undertake fundamental research on a bond’s value by looking at economic variables like interest rates and the overall status of the economy, then reviewing information about the bond issuer, such as probable changes in its credit rating.

The aim is to arrive at a figure that can be compared to the present price of an asset to determine whether it is undervalued or overpriced.

Fundamental analysis is based on both qualitative and quantitative publicly available historical and current data. This includes company statements, historical stock market data, company press releases, financial year statements, investor presentations, information found on internet fora, media articles, and broker/analyst reports.

Technical analysis

Technical analysis (TA) is a trading discipline that analyzes statistical trends acquired from trading activity, such as price movement and volume, to evaluate investments and uncover trading opportunities.

Technical analysis, as opposed to fundamental analysis, focuses on the examination of price and volume. Fundamental analysis aims to estimate a security’s worth based on business performance such as sales and earnings. Technical analysis methods are used to examine how variations in price, volume, and implied volatility are affected by supply and demand for a security. Any security with past trading data can benefit from technical analysis. This includes stocks, futures, commodities, bonds, currencies and other securities. In fact, technical analysis is much more common in commodities and forex markets where traders focus on short-term price fluctuations.

Technical analysis is commonly used to generate short-term trading signals from various charting tools, but it also helps to improve the assessment of securities strengths or weaknesses compared to one of the broader markets or sectors increase. This information helps analysts improve their overall rating estimates.

Technical analysis is performed on quantitative data only that recent and historical, but publicly available. It leverages mainly market information, namely daily transaction volumes, stock price, spread, volatility, … and performs trend analyses.

Link with market efficiency

When linking both approaches to investment to the market efficiency theory, we can state that fundamental analysis assumes that financial markets are not efficient in the semi-strong sense, whereas technical analysis assumes that financial markets are not efficient in the weak sense. But the trading activity of both fundamental analysts and technical analysts make the markets more efficient.

Useful resources

SimTrade course Market information

About the author

The article was written in November 2022 by Henri VANDECASTEELE (ESSEC Business School, Master in Strategy & Management of International Business (SMIB), 2021-2022).

Financial markets are not accounting enough for the Ukraine-Russia conflict

Financial markets are not accounting enough for the Ukraine-Russia conflict

Geopolitical events and financial markets

Some historical perspective: the 1973 Yom Kippur War

What about today (update November 2022)

Link with market efficiency

Useful resources

Related posts on the SimTrade blog

About the author