How the S&P 500 will react to three Russia-Ukraine scenarios, according to a UBS machine-learning model

Published Thu, Mar 3 20222:27 PM ESTUpdated Thu, Mar 3 20223:36 PM EST

As geopolitical risk rules market action, UBS used machine learning to predict how U.S. stocks could react to different scenarios in the Russia-Ukraine conflict. Russia's invasion of Ukraine entered its second week Thursday. Financial markets have seen heightened volatility as traders assess the risk of the war. "The Russia/Ukraine conflict presents significant uncertainty for equities," UBS's Keith Parker said in a note Wednesday. UBS used its machine-learning model, employing an algorithm called XGBoost, to assess market and sector reactions to different scenarios. "Our machine-learning model combines weekly returns of absolute and relative market and sector returns with fundamental variables to explain key relationships and drivers," Parker said. "Our findings suggest rising risk-premia could be counterbalanced by looser financial conditions and vice versa." Take a look at three scenarios the machine-learning model evaluated and their implied market impact. Scenario 1: De-escalation If the war between Russia and Ukraine reaches a resolution fairly quickly, the model sees the S & P 500 rallying in the next few months, as risk recedes and strong earnings revisions boost stock performance. Then, the model predicts the index would remain little changed in the second half of the year as financial conditions tighten and economic growth slows. S & P 500 Targets End of June: ~4,800 End of December: ~4,750 First-half outperformers : Banks, transportation First-half underperformers: Food and beverage, communications and professional services, telecommunications Second-half outperformers: Defensive sectors, financials Second-half underperformers: Cyclical sectors, consumer durables and capital goods Scenario 2: Conflict and uncertainty persist If the conflict between Russia and Ukraine continues into the first half of 2022, the model predicts the S & P 500 would rebound modestly. Although geopolitical risk would weigh on equities, the market may lower expectations of the pace of the Federal Reserve's rate hikes. In the second half of the year, the S & P 500 would likely "tread water" as the Russia-Ukraine risk eases amid the rising expectations of Fed tightening, according to UBS. S & P 500 Targets End of June: ~4,550 End of December: ~4,625 First-half outperformers : Energy, defensive sectors, pharmaceutical, telecommunications First-half underperformers: Cyclical sectors, consumer services, banks Second-half outperformers: Utilities, food, staples, consumer services, financials Scenario 3: Conflict further escalates If the war between Russia and Ukraine escalates further, the UBS model sees risk weighing on the market. Growth and earnings revisions would also slow, the model predicts. On the flipside, UBS said investors could price out Fed hikes, which would buoy equity markets. In the second half of 2022, geopolitical risk would retreat, but political uncertainty and financial tightening would be an obstacle for stocks, according to the model. S & P 500 Targets End of June: ~3,750 End of December: ~4,300 First-half outperformers : Defensive sectors, energy, materials First-half underperformers: Cyclical sectors, financials Second-half outperformers: Utilities, software and services, financials Second-half underperformer: Energy —CNBC's Michael Bloom contributed to this report.

Trader Peter Tuchman works on the floor of the New York Stock Exchange (NYSE) in New York City, U.S., March 1, 2022.

Brendan McDermid | Reuters

As geopolitical risk rules market action, UBS used machine learning to predict how U.S. stocks could react to different scenarios in the Russia-Ukraine conflict.