Geopolitical risks rarely have a persistent impact on equity-market volatility. China remains a bigger influence on the health of the US stock market.
If ever it was thought Kremlinology was a dying art, all it takes is a crisis in Russia to mint a few thousand more instant Kremlinologists to put any fears to bed. After developments in the country this weekend, we have a phalanx of competing theories about what it all means, and what happens next.
In truth, all we can really be sure of is this means more uncertainty. But, as always the crux of the issue for investors is, what does this mean for markets?
With a depressed VIX, the index might seem poised for a rapid and persistent move higher (it’s up one point so far today). That might happen of course, but it’s not a shoo-in. The chart below shows the correlation between the Global Geopolitical Uncertainty Index and the VIX. As can be seen, most of the time the correlation is between plus and minus 30%, i.e. essentially uncorrelated.
There have been only a few periods, marked on the chart, where it has spent much time outside the low correlation zones. Two of the times it’s fairly obvious why, and the time in 2014 is around when Russia annexed Crimea, but it’s not clear if that was the catalyst (or one of them).
Nonetheless, it illustrates the point that stock markets are rarely persistently affected by geopolitical uncertainty.
More impactful today (unless, of course, there is a rapid escalation in the situation in Russia) for US stocks and volatility is China. The economy seems unable to bounce back from the pandemic, with another sign of the malaise in weaker-than-expected spending over the recent holiday.
The yuan has weakened to a seven-month low versus the dollar, as well as weakening against several other Asian currencies. Inflation has remained stubbornly low, but policy makers in China do not have infinite patience and are likely to keep incrementally easing fiscal and monetary policy.
There is a strong US and global disinflationary trend at the moment, allowing the Fed to ease back, stocks to rally and the VIX to remain low. But when China eases further, it starts the timer for that favorable wind coming to an end.
