Russia has invaded Ukraine. Unfortunately, there's nothing much you or I can do except give our moral and financial support to the Ukrainian people and organizations trying to help.
If you're looking for a donation idea, check out World Central Kitchen, which is providing warm meals to Ukrainian refugees. Let us hope there is a quick end to the unnecessary bloodshed.
If you haven't realized it by now, black swan events happen all the time. They happen so often we might as well get rid of the term altogether. Please try and adopt some humility when it comes to investing and life overall.
Financial Samurai was born out of a black swan event, the global financial crisis of 2008-2009. Therefore, this site's DNA will always contain a cautionary strand or two. If you've ever lost a lot of your money and your livelihood, you will never want to repeat that experience again.
As an ongoing student of finance, here are five financial observations since the start of the war. These financial observations may help you better protect your way of life.
Five Observations Since The Start Of The War
Financial observation #1: Cryptocurrencies are not a defensive asset under normal circumstances
There has been some debate regarding whether cryptocurrencies like Bitcoin and Ethereum are defensive assets. One idea is that as the U.S. dollar loses its purchasing power, cryptocurrencies will eventually rise up and replace it. The thing is, the USD has appreciated since the pandemic and the war began, not depreciated.
Below is a chart of how Gold (gold line) and Bitcoin (blue line) performed once the invasion began. The red circle shows how Gold surged in value while Bitcoin plummeted in value. Once risk appetite returned, due to a relief rally that the invasion had finally begun, Bitcoin started surging in value while Gold started losing value.
Don't buy cryptocurrencies to hedge against a downturn. Buy cryptocurrencies for upside beta during risk-loving times. Gold works as a much better hedge during times of uncertainty.
However, the Ukrainian Russian war is an exceptional event. Few believed a war would happen. Fewer still believed so many sanctions would take place so heavily and swiftly. Once Russia got cut off from SWIFT, the international banking exchange system, Bitcoin surged. The demand for crypto went up because the Ruble, the Russian banks, and the entire stock exchange collapsed.
Below is a chart asking whether Bitcoin is a risk asset or safe haven by tracking its correlation to the S&P 500.
Finally, here's another chart that highlights how Bitcoin's price movement is highly correlated to the NASDAQ's price movement. If there was a time for Bitcoin to outperform, it would be during heightened geopolitical risk, high uncertainty, and high inflation. But it is not outperforming yet.
Financial Observation #2: Uncertainty kills the market
Fear of the unknown is one of the biggest negatives for the stock market. The greater the speculation about a Russian invasion of Ukraine, the more the stock market sold off. Only when the invasion actually occurred did the stock market finally turn around and rally.
Besides the fear of an invasion, here are other uncertainties that may hurt stock market performance to varying degrees:
- Concern over the magnitude and the number of rate hikes by the Fed
- Fear over the outcome of a presidential election
- Concern over who will be nominated to the supreme court
- Fear over the impact of a new deadly virus
- Worry over a new tax hike or change in tax policy
- Concern over a reduction in government benefits
- Fear World War III might ensue
The more we know about an outcome, the more we can take steps to deal with the outcome. However, to really benefit, you need to take action before the result is known. In other words, you need to take risk.
When it comes to investing, there is never a 100% certainty any result is known. As a result, we always need to think ahead and practice predicting the future.
Financial Observation #3: Extremely powerful and wealthy people are willing to detonate their finances for their ideology
We may think the Federal Reserve and other central banks are the most powerful entities that can determine the direction of the stock market. However, in reality, men like Vladimir Putin are more powerful than them all.
Putin was willing to destroy the Moscow stock exchange in order to go to war. On Thursday, February 24, 2022, the day of the invasion, the benchmark MOEX Russia Index closed 33% lower, erasing $189 billion in shareholder wealth. Meanwhile, the S&P 500 closed up 1.5% for the day.
This is the first time since 1987 that a selloff of this magnitude has hit a market worth more than $50 billion. In the aftermath of the Black Monday crash that year, Hong Kong’s Hang Seng Index tumbled 33%. The worst single-day drop over the past century in any market of any size was Argentina’s 53% slump in January 1990, when the country was battling hyperinflation and a mounting economic crisis.
The MOEX Russia Index now trades at roughly 2X forward earnings, down from 5.4X at the start of 2022. The earnings multiple of the MOEX reflects the risk premium required for investors to invest in such a market. The more power that is concentrated in the hands of a few unpredictable people, the riskier the market.
With Russia now facing tremendous sanctions by the West, the Ruble also depreciated by 50%+ as well. Even with a hike in Russian interest rates to 20%, few want to hold Russian assets anymore. The Russian discount will likely last for years, if not forever. Be careful of home country bias investing!
Therefore, you should probably continue to overweight developed countries with highly functioning democracies. After witnessing how well the U.S. has performed since the start of the pandemic, I will keep 90%+ of my investments in America.
Financial Observation #4: Compared to stocks, real estate is an oasis during a war
If you own both stocks and real estate, think about the amount of time you spent worrying about your stock portfolio versus your real estate portfolio during the onset of the war. Be honest with how many times you checked your stock app and logged into your online brokerage account before and after the invasion began.
Now think about how many times you thought about how your real estate portfolio was doing. If you are like most people, you probably worried much more about your stocks than your real estate.
It's only if you own real estate in a country that is being invaded will you begin to worry. Depending on if the invading country wins and how aggressive they are, you could lose your property rights under a new regime change.
If you tend to be a more anxious person, stocks may not be for you. You must come up with an appropriate net worth exposure percentage so that you aren't feeling distraught with the urge to panic sell any time there is a big downturn.
If you've been feeling particularly jittery or moody during this latest geopolitical event, then you should probably lower your stock exposure. On the other hand, if you've gone about your business without feeling any stress, then you should probably increase your stock exposure. Know thyself!
Personally, I dislike the way stocks make me feel when they sell-off. After spending 13 years working in equities for two major investment banks, I've already had more than a lifetime of stock market rollercoaster rides. Therefore, I have a greater percentage of my net worth in real estate rather than in stocks.
Financial Observation #5: Big intraday reversals haven't proven to be good omens
When the Russian invasion began, the NASDAQ began the day down 3.29%. It then ended the day up 3.36%. The S&P 500 started the day down 2.59%. It ended the day up 1.5%.
There were plenty of 5%+ NASDAQ intraday reversals during the 2000 dotcom meltdown and the 2008 global financial crisis. I was around during the 2000 tech bear market and there were so many false hopes. Therefore, have a lot of skepticism about the latest turnaround. There will undoubtedly be more volatile times ahead.
Below is a good historical chart showing the historical drawdowns since 1980. 10% – 20% corrections are quite common.
A War Could Ignite A Bull Market
One scenario worth thinking about is whether Putin actually helped stop a bear market from forming. This might sound ridiculous. But hear me out.
During a recession, governments tend to spend and print more money to get their economies going again. For example, on May 6, 1935, President FDR issued executive order 7034, establishing the Works Progress Administration (WPA). Over its eight years of existence, the WPA put roughly 8.5 million Americans to work, helping America get out of the Great Depression.
During a war, there is heightened military spending that creates employment and additional economic activity. More money may be spent on innovation and technology. However, there is obviously a cost to many other industries. Therefore, the jury is out on whether this war could reignite an upward momentum in stocks again. The only evidence we have so far is the relief rally in the U.S. stock markets since the invasion began.
However, here is how a war might actually help the stock market:
- Makes the Fed second-guess their rate hike plans, which could help spur further borrowing
- Attracts more treasury bond-buying, which helps put a lid on rising interest rates
- May reduce consumption froth and reduce inflation as more people hold cash and spend less
- Encourages other nations to collaborate, creating more opportunities for international trade
- May eventually motivate more people to spend their money on goods and experiences, which helps boost economic activity and corporate profits
Stubbornly High Inflation For Longer
Given Russia is a top-three producer and exporter of oil, energy prices will likely stay elevated for a while. As a result, inflation will likely also stay elevated, at least until the war's worst ends.
Below is a good chart from the Federal Reserve that highlights six episodes of post-WW II elevated inflation. After each period of elevated inflation, there was a collapse in inflation prices as market forces went to work.
There is also a rising concern for stagflation, which is the simultaneous increase in inflation and stagnation of economic output. However, the default assumption continues to be that inflation will eventually abate within the next 12 months while economic growth continues as we exit the pandemic.
Personal Consumption Trends
After two years of higher-than-normal saving, investing, and working, I plan to spend more money over the coming 12 months, not less. My intention to revenge spend is high as we get back to normal. The typical U.S. consumer has “excess savings” accumulated since 2020.
Although it now costs over $100 to gas up my car, I will still drive my boy to school during the weekdays and drive to tennis matches on the weekends. Purchasing an electric vehicle will have to wait until 2025 when my current car reaches 10 years old. I only drive about 4,500 miles a year.
Thankfully, the northern hemisphere is entering warmer seasons, which should mean lower home heating bills. We don’t use much heat here in San Francisco because it seldom gets below 50 degrees.
A pandemic and now a war are good reminders to not take life for granted. May there be peace soon.
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Readers, what are some other financial observations you have had since the war began? How are you thinking about your finances, your livelihood, and your future? If you want to receive my posts automatically through e-mail, sign up here. If you want more nuanced personal finance content, you can sign up for my free weekly newsletter.