Article: Factors in Regime Change—Fall of Soviet Union, Kosovo and Arab Spring…now Afghanistan

Damian Handzy, Jim Monroe | September 14, 2021

The evacuation of American and coalition troops and civilians from Afghanistan followed by the Taliban takeover prompted us to examine other episodes of regime change and how equity markets reacted.

We looked at the lessons from three big regime changes over 30 years: the collapse of the Soviet Union, the Kosovo War, and the Arab Spring.  This much is clear:

  • Defensive stocks, specifically the Quality sub-factor “High Gross Profits to Assets”, outperform
  • “Risk-On” stocks, notably Small Cap and High Volatility, underperform
  • US and Europe investors take a “risk-off” approach during periods of global political turmoil

We examined these time periods:

  • The six months from Aug 1991 to Jan 1992 (Collapse of Soviet Union),
  • The 14 months from May 1998 to June 1999 (Kosovo War) and
  • The 19 months from Jan 2011 to July 2012 (Arab Spring)

In the US and Europe High Gross Profits to Assets (a Quality sub-factor) stood out for its outperformance; and High Volatility and Small Cap for their underperformance.  The table below shows average monthly return in these periods, against the wider market:

* High Volatility stocks during the Kosovo war first lost ground and then recovered. If the Kosovo War is ignored, European High Vol stocks lost about 25 bps per month during the collapse of the USSR and the Arab Spring.

While several Quality sub-factors did well during these periods, the standout measure was High Gross Profits to Assets, a Quality sub-factor which consistently generates above-market returns over long periods of time. The underperformance of high volatility and small cap stocks during such periods is understandable: investors move away from higher risk investments during periods of uncertainty. 

In terms of timing, over the periods in question it took several months for these impacts to materialize.  That means it is still too early to tell how the Afghanistan withdrawal will play out, market-wise. It would not be surprising to see similarly defensive investment choices, supporting Quality and suppressing risk-on decisions.

The figure below shows how each of these sub-factors performed throughout each of the periods we examined.


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