When London’s Gresham Life Assurance Company completed its luxurious Art Nouveau headquarters in Budapest in 1907, it clearly did not anticipate that the world it was designed for would crumble apart in just a few short years amid the bloodshed of a world war, a pandemic, protectionism and a financial crash.
Much has been written about the impact of the Russian invasion of Ukraine on the global economy and markets – and the assessment has been that growth will slow somewhat in Europe and little in America; that there will be a temporary burst of inflation and stock markets will fall before they recover.
At first that was how it seemed to be playing out. Just 48 hours after Vladimir Putin’s troops launched the largest military incursion into Europe in 70 years, the US benchmark stock index, the S&P500, rose 6 percent from its invasion low.
That’s fast by historical standards, as research by portfolio manager Jens Nysted shows that a major geopolitical shock causes a median loss of 3.4 percent for the S&P500, and once that bottom is reached, the market recoups losses within five days .
It sounds like the kind of bet Gresham would have made in 1914 in a highly globalized world with mobile and abundant capital strikingly like ours. Inflation expectations were firmly anchored by the gold standard.
Financial market investors and traders are now conditioned to “buy the dip” which we have seen repeatedly throughout the Covid pandemic. And that itself is dangerous because it is self-reinforcing and triggers herd behavior.
According to historian Niall Ferguson, investors were unmoved in 1914 until World War I actually broke out.
“Apart from an upward movement in Austrian bond yields, there were no notable shifts in either the bond market, the money market or the foreign exchange markets up to the last week before the outbreak of war,” Ferguson wrote in a paper on past crises.
In other words, markets don’t see everything and don’t anticipate shocks like the ones we’re seeing in Ukraine, as we learned over the weekend as financial sanctions against Russia were tightened, causing equity prices to plummet and oil prices to rise. Market movements should not be confused with the reality of events shaping our world.
According to Ferguson, by 1920 any investor unwise enough to own UK government bonds would have seen real yields fall by 46 percent, while UK equity returns fell by 27 percent.
Of course, things were far worse for those, like Gresham in Budapest, who held assets in the Austro-Hungarian Empire, Germany or Russia, where the revolution swept communists to power, along with a default by the financiers.
But no two geopolitical crises are alike, as those who insist on buying the dip seem to believe. Putin has clearly developed greater ambitions than establishing footman states, as he did in Georgia in 2008 and Ukraine in 2014, but our risk assessment has not changed.
For example, if you assumed that the way trade was traded in World War II was the way money was made in World War I, you would have lost, notes Ferguson.
British stocks returned 50 percent from 1938 to 1948, outperforming the US market’s 25 percent, while you saw bond markets return 11 percent and 6 percent, respectively.
“Past experience would have led any sensible money manager to be overweight US stocks in 1939. The current knowledge that London was within range of German bombers but not New York only reinforced the lesson of history,” he wrote.
How could this play out in a way that could break the buy the dip scenario? One is where oil prices continue to rise and economies go into reverse gear at a time of persistently high inflation. That would shock markets at a time when governments have already stretched their balance sheets in the fight against Covid.
Putin may find he has little to lose now by stepping up the pressure on the former Soviet Union’s three Baltic states, which are EU and NATO members. Instead of a peaceful trading bloc of 450 million people, the EU may need to become more militarized. Another reason is that an angry and disgruntled Russia is turning against Putin and we have an unstable nuclear-armed state on the borders of Europe.
Ukraine and Russia are both major grain exporters to Arab countries like Egypt and Libya. Rising energy and food prices are putting pressure on budgets in poorer countries thanks to subsidies. Food price shocks can also lead to civil unrest, as was the case during the Arab Spring.
It seems that financial markets form habits easily and have gained immunity to shocks, particularly those that appear to be cyclical, such as the regular provocations served up to this day by North Korea or Putin.
Gresham Palace is now a Four Seasons Hotel. It opened in 2004, a century after its conception and 90 years after a “shot heard around the world” started World War I.
The building was once a barracks during communist rule in Hungary and there is even an Irish connection as Quinlan Private restored it to its former glory.
https://www.independent.ie/business/world/buy-the-dip-mantra-is-complacent-when-putin-is-redrawing-europes-map-41417639.html The “buy the dip” mantra is smug as Putin redraws the map of Europe