The markets have never believed in total war

In Europe, equity markets have recovered almost everything they had lost since the conflict began. In the US, it’s even better as markets have risen nearly 5% since that date. Finally, only emerging markets still appear to be affected by the explosion, as the Russian market is completely closed. What to think of this sufficiency of the stock markets while Europe is on the verge of nowhere?

Imagine that the prices of financial assets tell us something intelligent, we then deduce that investors do not seem worried about the evolution of the ongoing conflict. Sure, there was this moment of awe at the start of the conflict, with equity markets losing nearly -10% in one week. Then, very quickly, investors decided that the markets would not go down, buying back the financial assets they had sold. Clearly, escalation never seemed to be the scenario of choice for investors. Why ?

Excessive attention should never be paid to what is hidden in the price of a financial asset. Markets are an observatory and not a conservatory, we must not try to deduce great truths from great theories. The risk of excessive interpretation is as frequent there as it is for contemporary art critics.

It must be said that in the price of a financial asset we find everything: anticipations, emotions and obviously a little bit of irrationality. Consequently, the resilience of the stock markets in the face of the event receives several possible interpretations: the silent force of the wise, the fear of the ignorant, the daze of the happy fool. Difficult to choose which is the good face of the investor. Likewise, the face of the thinker always leaves a doubt: is he meditating or dozing? Jules Renard had an idea:

“He didn’t say anything, but we knew he was thinking nonsense.”

The Thinking Investor Hypothesis

Let’s take the thinking investor hypothesis. Those who make rational advances, for example, do not know the end of history, but deduce it: “if we apply all these economic sanctions, Russia will eventually give up, and the conflict will be over. It is therefore a Laplacian type investor, who claims to know the trajectory of the stock market in a deterministic way, precisely because he knows the initial conditions of the problem. This investor argues that the escalation of the conflict cannot take place, because Russia will surrender sooner. Strong of his demonstration of him, he anticipates that the stock markets will not remain to comb the giraffe: the markets must start to rise again, which in fact they are doing.

Not so naive. It must be said that theoretical finance offers somehow the same kind of reasoning. In the event of a major crisis, the investor would have the right to sell his shares, because they have become extremely volatile. That said, in the end he won’t sell too much, because the best protection against a market downturn … is to keep it.

We’re not laughing, this intellectual twirl assumes that any fall in the market generates what are called favorable conditions for its rebound (John Cochrane: Portfolios for Long-Term Investors). A crisis lowers the current price, but does not lower the “final” price. This final price is the one that reflects the intrinsic value of the stock, its own REAL value in some way. Therefore, there is a significant performance potential between the current price which has fallen and the final price which has remained stable. You just have to be patient to let the current price converge towards the final price, all of this provided of course that total war does not take place, otherwise the current price will never have time to converge. the final price …

Therefore, the extreme complacency of the stock markets in the face of tragedy seems justified only because the worst is removed from the horizon of possibility. The worst cannot happen. So it won’t happen.

But the history of finance is not very favorable to the thinking investor argument. At best he will recognize that he thinks badly. At worst, he will argue that the probability of the stupid investor hypothesis “borders on certainty”, to paraphrase Orest Chwolson, this 1930s Russian physicist. More elegantly, another History of Finance will be content to say that it is very difficult to separate wheat from Ivrea: we do not know if it is the investor who is stupid, or the model applied to test the investor’s stupidity (hypothesis test joined).

To us, these latest observations mean that the relative serenity of the equity markets during this conflict cannot be attributed with certainty to the investor’s daze, but that it looks the same.

The premise of without end of the world

That said, even if the confidence shown by the markets is startling, we can at least recognize some consistency in their words. Therefore, it will be noted that the hierarchy of returns observed across different asset classes is quite consistent with intuition. For example, US equity markets fared much better than more conflict-prone European markets. In terms of stock selection, there is a clear preference for energy stocks (oil, gas, etc.) to the detriment of banking and automotive stocks, which are considered the most vulnerable. Finally, investors have been trying to get rid of their government bonds, in a scenario where runaway inflation, the real one this time around, could cause central banks to tighten their monetary policies further.

So, from the moment you accept the premise of the no-end of the world, everything else follows naturally and seems quite consistent. Should we accept this premise? Yes, it seems to indicate the relative serenity shown by the markets. But as we have seen, this serenity is more an opinion than a true knowledge.

A nuance of which the philosopher Theodor Adorno had already noted the misdeeds:

“Opinion appropriates what knowledge cannot reach to replace it. It deceptively eliminates the gap between the knowing subject and the reality that eludes him.