Investors are living in a world permeated by multiple geopolitical conflicts. One might expect geopolitical shocks to create volatility in equities, which as an asset class do not usually respond positively to uncertainty, but are there some stocks that can perform defensively during geopolitical crises?
We previously looked at how stocks sensitive to government spending performed when facing a potential US government shutdown. Here we are interested in understanding how the market perceives government-sensitive stocks during times of heightened geopolitical uncertainty. Conflicts can potentially lead to surprise upticks in government spending, which may have a direct impact on these stocks.
To examine this, we will use the same government-sensitive basket of stocks, formed by calculating the amount of dollar exposure all US stocks have in terms of outstanding government contracts and retaining those with significant exposures. The nature of government spending means the sector concentration is highest in Industrials (35%), Healthcare (20%), and Technology (15%) as shown in Figure 1. There is recent performance data from the Russia-Ukraine conflict that we can analyse to understand the pattern of behaviour of this basket of stocks, which may act as a blueprint for potential price patterns in the event of future geopolitical clashes.
Figure 1. Sector exposure of stock basket
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Source: Man Numeric.
As shown in Figure 2, the basket of stocks in question shows resilience while the broader equity market (as represented by the S&P 500 Index) falls close to 5% in the two weeks following the news of the onset of the Russia-Ukraine conflict in February 2022. Further, the basket yields approximately 3.5% relative to the benchmark during this period. This is in line with our expectation that upticks in government spending may positively impact this basket of stocks.
Figure 2. Performance of stock basket during Russia-Ukraine conflict
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Source: Man Numeric.
Further investigating the resilience of these stocks, we find that the Industrials basket performs better than the basket overall. Digging deeper, we want to understand how much of this is from the stocks we select and how much is from the sector exposure (see Figure 3). We find that the basket delivers approximately 3% more than the sector on a relative basis as well. Decomposing performance this way gives us the finding that the Industrial stocks with government contracting exposure were more resilient than other stocks in the same sector.
Figure 3. Digging into the performance of Industrials
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Source: Man Numeric.
Next, we studied the sensitivity of this basket to announcements of aid packages by the US government as these announcements directly affect government spending. To avoid picking up sectoral trends, we look at sector-relative returns. Figure 4 shows that the selected basket yields approximately 3% over the two weeks following the first three aid package announcements.
Figure 4. Basket returns around the first batch of US government assistance packages for Ukraine
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Source: Man Numeric.
Conclusion
The above analysis of the Russia-Ukraine conflict provides us with an ex-ante view of equity performance, which could apply to future geopolitical conflict scenarios. It indicates that there are baskets of stocks that demonstrate resilience owing to an increasingly positive outlook on government spending patterns. More broadly, with careful analysis, it also suggests that there are some stocks that can perform defensively for investors in the face of future geopolitical crises.
With contributions from Aditya Divekar, Associate Quantitative Researcher, and Diana Zheng, Quantitative Researcher, at Man Numeric.
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