Navigating in Times of Crisis
On Saturday, October 6th, we awoke to a true point of inflection as result of the horrible attack on Israel and the reality of war in the Middle East. Obviously, much like the ongoing war in Ukraine, this is very concerning and heart-breaking for all involved, especially innocent civilians.
When global conflicts arise, investors are typically encouraged to take it in stride and not panic–give a risk-appropriate asset allocation is already in place. But some investors seek out these negative points of inflection — tactically implementing themes to sort the winners from the losers regardless of underlying fundamentals. To this, we say tread carefully. Here are some of the more popular current examples:
Buy oil. Obvious, right? Trouble in the Middle East, oil prices will skyrocket. We’re off to a solid start. Since Friday, October 6th – the last trading day prior to the Hamas terror attacks in Israel – oil is up 6.7% while the S&P 500 Index is up 0.2%. However, given the circumstances, most would not have expected such a muted response from a commodity with such well-publicized supply challenges. Since Israel is not an oil producer, part of this thesis hinges on an expansion of the current hostilities to neighboring oil producing countries, most notably Iran. So far, this doesn’t seem likely as long as the US is seen to credibly be willing to intercede to defend Israel. Over a longer period, this evidence is less convincing — oil prices actually declined by 10.1% through 10.6.23 (before Hamas attacks) since Russia’s invasion of Ukraine on February 24, 2022, while the S&P 500 has risen by 4.7%. Turns out, sanctions only matter if they are enforced. And key players have had every reason to “look the other way” during a period of high inflation and potentially crippling energy costs.
Buy defense contractors. War requires weapons, munitions, and war-fighting infrastructure. Rumors abound of supplies running low for important weapons with almost unceasing demand as conflicts rage around the world. So far, it’s been a good trade with the iShares US Aerospace and Defense ETF (ITA) up 5.0% vs. the S&P 500 Index up only 0.2% since the onset of hostilities. Again, longer-term results have been mixed — similarly, since immediately prior to the start of the war in Ukraine, the ITA is up 4.1% while the S&P 500 Index is up 4.7% — underperforming the broader market. Although, we will say that in the long run, we are likely to face a multi-year restocking cycle to replenish depleted stockpiles. Oh, and don’t worry about defense contractors that produce weapons of war meeting ESG requirements – conveniently, according to a March 2022 Capital Monitor article (Why ESG funds are full of weapons) many ESG strategies changed their rules to allow for the ownership of defense contractors leading up to and immediately after Russia’s invasion of Ukraine. They quote two Citi analysts who state the defense is “likely to be increasingly seen as a necessity that facilitates ESG as an enterprise as well as maintaining peace stability and other social goods.” They point out that nearly 52% of ESG funds contain exposure to military weapons (compared to 67% of regular funds), another example of how the ESG moniker can be engineered to encompass literally anything.
Buy cybersecurity companies. We are entering an age where cyber is a new battle front to disrupt not only military command and control, but also civilian economic infrastructure. As we have also seen both in Ukraine and Israel, digital propaganda and disinformation will also play an increasing role to win the battle of public opinion globally. So far, this trade is slightly positive with the iShares Cybersecurity ETF (IHAK) up 0.5% vs. the S&P 500 Index up 0.2% since the onset of hostilities. Once again, the picture changes when the trade is considered over a longer period — since immediately prior to the start of the war in Ukraine, the IHAK is up 2.9% while the S&P 500 Index is up 4.7% — underperforming the broader market. Keep in mind, however, that this theme is seen as more indirect in terms of capitalizing on the immediate crisis, and these stocks can be influenced by other factors, like the fact that these companies usually trade at higher multiples (w/higher growth) in a rising rate environment. Again, we think as a long-term theme, this one should have legs.
Sell Israeli stocks. Well, that was easy. Obviously, a war will significantly disrupt economic activity within Israel and will be costly in many ways. In fact, the iShares MSCI Israel ETF (EIS) is down 11.3% over this same time period (10.6 -10.18) while the iShares MSCI Emerging Markets ETF (EEM) is down 1.0%. However, most of this decline occurred on the Monday after the attacks (down 7.1%), so unless you were already held this position on Friday, you missed most of it. And remember, this is the same assumption we made about Russia, compounded further by global sanctions. After initially dropping almost 50% in the days leading up to the invasion, including a 33.3% pullback on 2.24.22, the index has recovered dramatically, up 52.5% since 2.25.22. That said, currently the Russian stock market has not been available to US investors due to US government sanctions, trading restrictions by US exchanges and a ban from Russia for “non-friendly” countries. Nor are most Russians allowed to invest outside of Russia due to capital controls; therefore, leaving Russian stocks as the only alternative. Suffice it to say, we take this dramatic outperformance with a grain of salt.
Points of inflection can be positive or negative. And there will always be times of global crisis. Even if you wake up early and see an inflection before it unfolds, there’s still plenty left to do to make an investment and get a meaningful return. Timing is often everything and you better be quick on the trigger and disciplined in your exit. Who knows? The risk could be worth it. Just make sure it’s an appropriate allocation to your long-term invest plan.
Validus Growth Investors, LLC is a global investment manager that seeks to invest in companies at every stage of their growth. From startups to publicly traded companies, our research identifies inflection points that have the potential to produce meaningful growth and income for the clients we serve.
Source of statistics: Bloomberg, Validus Global Investment Research
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