What does the history suggest about geo-political risk and equity returns?

We took the value of Sensex to know the impact of geo-political risk on the Indian equity market.

On Monday (February 21, 2022), Russian President Vladimir Putin recognized the independence of two Russian-led breakaway regions in eastern Ukraine and ordered troops to the separatist territory. This has increased the possibility of invasion into Ukraine by Russian forces and spooked the equity market globally. 

The worst damage seems to be borne by the Russian equity index, which is down by more than 6 per cent at the opening after witnessing a 10 per cent cut in yesterday’s trade. 

Even other equity markets globally are trading weak since this problem started a couple of weeks ago. All the Asian markets are trading in red with a cut of more than one per cent. Nonetheless, the European equity market is trading in green while the future index of US equity has also turned positive after showing a deep cut in morning’s trade.   

As the world anxiously keeps a close eye on tensions between Russia and Ukraine and reactions by other countries including the United States, we examined market moves around past geo-political crises for cues as to what investors might expect in future. 

We took the value of Sensex to know the impact of geo-political risk on the Indian equity market. We have Sensex data from April 1979. The first geo-political risk after Sensex came was in form of an invasion of Afghanistan by USSR in December 1979. There was no reaction to such an attack and Sensex saw a good return in the coming one, three, six months and one year. 

Following table shows the returns after a certain period of the event date 

Last time Russia invaded Crimea (2014) and annexed it, even than the market did not react much. In fact, the Indian equity market reacted to WTC Bombing and Sensex saw a lacklustre performance. Nonetheless, such reaction was more due to dot-com bust and scam that our market went in the year 2000.  

In all other cases, we see the market is not much deterred by such geo-political risk.   

Following diagram shows the drawdown of Sensex from the event date till the next one year. The blue dashed line shows the event date and red dashed line shows the three months after the event date except for WTC Bombing.

Highest drawdown in Sensex was seen in case of invasion of Kuwait by Iraq. Besides, rise in crude oil price domestic political instability during that time led to such large fall in the Sensex.   

We do not see much risk of current tension between Russia and Ukraine. The bigger risk that we saw is higher inflation, sucking of liquidity and rising interest rate. These factors will play larger role in determining the returns of equity market in next one year.