Macroscope | As stock markets rally despite Ukraine war and inflation, investors seem to have new appetite for risk

Is the sudden recovery of US and EU stocks a sign that investors are underestimating the impact of Russia’s war, or is their focus back on inflation?

More likely is that the rise reflects the fierce volatility of the market, and with more twists and turns to come, investors are seeking gains wherever they can

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Traders work on the floor of the New York Stock Exchange as Ukrainian President Volodymyr Zelensky is shown addressing the US Congress on March 16. Photo: AFP

Published: 1:30am, 25 Mar 2022

Have global investors taken leave of their senses? Russia’s war in Ukraine, the largest military offensive in Europe since the second world war, shows no sign of ending any time soon, and could well persist for many months. Yet, last week, European and US stocks enjoyed their strongest weekly gains since November 2020.

The sudden recovery in equity markets, which had fallen sharply as the conflict escalated, is particularly striking in Europe, whose economies are more vulnerable to the fallout from the West’s sanctions on Russia. Some 40 per cent of Europe’s natural gas imports and almost a third of its crude oil imports come from Russia.

While markets move in mysterious ways at the best of times, and have proved resilient to all sorts of geopolitical threats in the past, Russia’s invasion of Ukraine is hugely consequential for the global economy and markets.

A month ago, the surge in inflation and the hawkish shift in monetary policy were the overriding concerns of investors. Yet, in Bank of America’s latest fund manager survey, published on March 15, the conflict had shot up to the top of the list of the biggest “tail risks” in markets.

How is it possible that a geopolitical shock, which investors themselves believe poses the biggest threat to growth and asset prices, has not had a more lasting effect on sentiment? While last week’s equity rally may be a dead cat bounce, and the prelude to sharper declines as the war intensifies, it is remarkable that markets recovered so quickly.

This begs the question whether investors are underpricing the risk that the conflict could escalate even more dramatically by drawing in one of the east European members of Nato. Poland, the most hawkish member of the US-led military alliance and the one whose 500km border with Ukraine is the most dangerous flashpoint for Russian retaliation against Nato, is particularly at risk.