Geopolitical Shocks and Stocks

• 13 August 2025
• finance
• international relations

Geopolitical shocks typically have little lasting impact on US stocks. Research by JP Morgan studied 36 events, beginning with Germany's invasion of France and ending with Russia's invasion of Ukraine, and found that the six month return starting from the day of a shock was indistinguishable from the return over any random six-month period that didn't cover a shock. Intuitively, geopolitics should play a substantial role in stock prices, but research consistently shows that they rarely do. Basic financial modeling provides insight into both why this is the case and what to look for the next time a global event causes the financial press to fret.

Economists and investors from Irving Fisher to Benjamin Graham and his protégé Warren Buffett have long argued that a company's cash flows over the long-run determine a stock's intrinsic value. Cash flows are fundamental because they can be reinvested into the company to fuel growth or paid back to an investor via dividends or stock buybacks.^[1] The goal in this valuation approach is to buy companies priced below their intrinsic valuation and sell those that are overpriced. Although stocks may fluctuate for various reasons in the short-term, value investors argue that cash flows over the long run are what truly drives returns.

Since cash flows in the long run shape returns, stock prices should reflect the market's best guess about these future cash flows. An event that leads investors to revise this guess should then impact the stock's price. Academic/investor Michael Mauboussin and Alfred Rappaport emphasize three fundamental drivers of a company's valuation where shifts can impact a stock's price by changing the market's expectation of future cash flows: 1) sales/revenue growth 2) operating margins and 3) incremental investment.^[2] These three channels can offer guidance into a geopolitical shock's impact on equities.^[3]

According to Goldman Sachs about 28 percent of the revenues for S&P 500 companies come from abroad. But large US companies in the S&P 500 are globally diversified, meaning they typically have few, if any, sales in countries where crises generally occur. For investors to update their expectations of sales growth sufficiently to sell their shares, the shock would likely need to be regional or global and hit several export markets. Therefore, because most revenues coming from within the US and those who export have diversified markets, a shock would have to hit a company's vital export markets quite hard to cause long-term stock price declines.

Although large companies have diversified sales, they may have concentrated supply chains where shocks can negatively impact both operating margins and incremental investment. Operating margins relate to the costs of doing business in the short term, meaning it excludes things like financing and long-term investments. If input prices increase, operating margins will fall. The 1970s oil shock was the one event in the above JP Morgan report that had lasting impacts on equity prices as high oil prices increased costs across the economy.

But not all shocks drive up prices, in part because of the dollar's role in the international financial system. Typically, crises lead investors to invest in safe assets, and US government bonds are considered the safest. This "flight to safety" can strengthen the dollar, thereby making imports cheaper. Since most imports to the US are used in intermediate goods, a decrease in import prices can improve operating margins, all else equal. Although many commodities, such as oil, are priced in dollars, and a stronger dollar can make a company's exports relatively less competitive, for many large firms, a stronger dollar can reduce operating costs.

Some firms may own, or be significant investors in, factories abroad. If a shock hits these factories, these firms may need to diversify. Although being forced to make new investments in property, plants, and equipment may be an inefficient use of their capital, a diversified supply chain provides resilience to future shocks, thereby reducing the uncertainty of future cash flows, which increases their present value. For long-term focused investors, this diversification may be a net positive, cancelling out the negative short-term impacts on the stock price.

We can see some of these drivers at play after Russia's invasion of Ukraine. McDonald's was one of the most exposed companies to the war with nearly 9 percent of its revenues coming from the two countries. But as the following table shows, its stock outperformed the S&P 500 (measured by the SPY index) throughout the year following Russia's invasion.

If we took the geopolitical shock and potential revenue loss at face value, we may have expected a significant drop in its stock price. Although 9 percent of revenue seems substantial, McDonald's owned and operated 100 percent of its restaurants in Ukraine and 84 percent of those in Russia, making this revenue come with high operating costs. Subtracting the cost of operating these restaurants caused this 9 percent of total revenue to equal less than 3 percent of its total operating income. These low-margin company-operated operations contrasted with McDonald's high-margin franchise model, likely making these stores less valuable to investors. Furthermore, this income exposure seems relatively small considering the broader 2022 macroeconomic environment.

Post-pandemic inflation led to significant Fed tightening, with prominent economists predicting a recession by the end of 2022. As the Economist notes, McDonald's in the US is relatively insulated from inflation because it makes most of its revenue through franchise fees and taking a fixed percent of total sales (not profits). Simultaneously, it is also a good bet in the event of a recession, as its low prices attract more price-conscious consumers. Therefore, considering the broad macroeconomic context, investors may have liked McDonald's freeing up a substantial amount of capital by shutting their relatively low-return, low-franchise-fee, operations in Russia and Ukraine. As such, over the next year, McDonald's significantly outperformed the S&P 500 even though on paper it seemed quite exposed to the war in Ukraine.

Despite our intuition, and what we read about in the financial press, empirical studies consistently find minimal impact from geopolitical shocks. These findings are consistent with valuation approaches to equities, as shocks often leave a stock's core value drivers relatively unscathed. This is not to say geopolitics never matters, but when the next crisis occurs, analyzing fundamental value drivers can help us better assess how much that shock will impact stocks.

Footnotes #

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