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Why Stocks Rebounded After Russia Invaded Ukraine

The aftermath of overnight shelling in a residential area in Kyiv.
Photo: sergey dolzhenko/Shutterstock

Russia invaded Ukraine to start the biggest land war in Europe since Hitler. U.S. stocks soared. What gives?

It isn’t that Wall Street secretly loves Vladimir Putin. A close look at the market’s performance on Thursday shows the reality: U.S. equities had a near-perfect reverse of what had been going on this year. It was a great stock-market switcheroo.

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Russia invaded Ukraine to start the biggest land war in Europe since Hitler. U.S. stocks soared. What gives?

It isn’t that Wall Street secretly loves
Vladimir Putin.

A close look at the market’s performance on Thursday shows the reality: U.S. equities had a near-perfect reverse of what had been going on this year. It was a great stock-market switcheroo.

Stock gains continued on Friday in the U.S. and elsewhere, with Russian shares leaping by a fifth in ruble terms. But it was Thursday’s move that set the tone, and which was so extraordinary on the day Ukraine was invaded.

Technology and other growth stocks that were clobbered in the first month and a half rebounded hard on Thursday, while oil, banks and other cheap “value” stocks that had done relatively well this year fell back. The link between doing badly for the year up to Thursday and doing well on Thursday was strong, and vice versa. Quite why is less clear, but I have theories:

Sentiment was depressed, and a moment of panic-selling hit when the market opened, with the CBOE Vix index of implied volatility hitting its highest opening level since 2020. I quoted yesterday a line usually (and probably wrongly) attributed to legendary banker Nathan Mayer Rothschild, but another captures the fear that war brings to markets: “Buy on the sound of cannon, sell on the sound of trumpets.” When fear dominates, it’s time to buy, and many did. Fear receded, tracked by the price of gold giving back all its gains to end the day lower than it started.

Why was the reverse so quick, though? One reason could be that investors were already so worried that it didn’t take much to hit rock-bottom and so rebound. The regular American Association of Individual Investors survey this week found the highest proportion of self-described bears in almost a decade, and close to the lowest proportion of bulls.

Last week’s Investors Intelligence examination of newsletter writers found bearish sentiment almost equal to bullish for the first time since the March 2020 selloff. And a 10-day smoothed measure of investor opinion from the options market showed the equal-highest proportion of buying of bearish puts (used to protect from falls) to bullish calls (used to bet on rising stock prices) since shortly after the pandemic panic began.

One test of the private-investor mood is the meme stocks of
GameStop
(up 8% on Thursday) and
AMC Entertainment
(up 12%), which are so disconnected from reality that sentiment dominates. But both dropped on Friday, as the rally became more discriminating.

Sentiment doesn’t usually turn on its own though, and can explain only part of Thursday’s reverse – although a better tone was clear on Friday too.

Conflicts like Russia’s invasion of Ukraine have historically sent stock prices lower and boosted the value of certain commodities. WSJ’s Dion Rabouin explains the investor psychology that’s moving markets. Photo: Justin Lane/EPA-EFE/Shutterstock

Fundamentals were also very helpful. These split roughly into two. First, the sanctions imposed on Russia were less bad than they could have been. Investors who feared a bigger hit could thus take more risk again. Russia’s major exports will be untouched, with exemptions for energy and agriculture sales. That’s good for the West’s economy, as it reduces the risk of a massive jump in energy costs; it’s bad for the oil and gas stocks that had been doing well this year (also hurt by the promised release of U.S. strategic oil reserves). The sanctions with the most bite are on Russia’s banks, which aren’t great for banks elsewhere.

Second, the Federal Reserve is expected to slow the pace of rate rises a little, with the chance of a first half-point hike next month receding, according to futures market pricing. The probability of rates rising from zero now to 2% in a year’s time dropped from more than a third to just over a quarter. Investors who think there’s less risk of really extreme Fed moves are more willing to take risk. The tech and other growth stocks that had been hit so hard by the expectation of rapidly rising rates naturally rebounded the most.

Finally there’s the technical issue of short-covering and deleveraging. It is hard to know in real time how much of an issue this was, but the pattern fits that of a generalized retreat from trading on borrowed money. Leveraged investors such as hedge funds and momentum traders buy back stocks they had bet against, or shorted—such as GameStop or the tech and growth sectors that had been in decline for months—and sell stocks that had been bought on margin, to reduce their borrowing. Sharp market reversals are typically exacerbated by a rush to deleverage.

Any of these could change. Sentiment by its nature can swing about, and while it is good sense to buy when others are fearful, they can always get more fearful. Sanctions could be beefed up, especially if Russia’s actions enrage public opinion in Europe enough that Germany’s politicians judge that it’s worth accepting the pain of still higher natural-gas prices. And by its nature the effect on stock prices of deleveraging doesn’t last, and on Friday there was no evidence of deleveraging in price moves.

For now it looks like traders are judging that Ukraine won’t be bad for Wall Street. But remember two things: Just a few days ago the same people judged that a full-on invasion was unlikely, and that if war makes stocks rise, peace—the sound of trumpets—should herald a pull back. At the very least, expect markets to keep swinging about.

Write to James Mackintosh at james.mackintosh@wsj.com

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