Initial Thoughts on the Russia-Ukraine Situation
As market volatility picks up as a result of the Russia/Ukrainian conflict, we wanted to share some of our thoughts on the markets (below/attached). Please note, these comments are intended to focus on the market impact, not to understate the humanitarian fallout. We hope for a peaceful and swift resolution.
Russia has commenced an invasion on its Western neighbor, Ukraine. The situation remains very fluid, but likely came more quickly than expected which leaves Ukraine and its allies unprepared as they have just begun to establish next steps. Markets never like uncertainty, so we expect things to be bumpy for awhile.
Why is Russia invading Ukraine?
The official line states Russia is invading to protect Russian citizens, especially those in the self-proclaimed Russian republics of Donetsk and Luhansk who declared such independence in 2014 when Russia last invalided Ukraine. However, Russian interests go much deeper. The collapse of the Soviet Union in 1991 left Russia vastly depleted from its former days of empire building. Security analysts believe this “one people, single whole” mentality is the true root.
What is happening in Ukraine?
Overnight, Russia launched a series of coordinated attacks on key military targets across the Ukraine including air, ground and amphibious assaults. The situation remains fluid.
How have markets reacted?
As expected, risk assets have retreated on the unfortunate news. Equities broadly, even those with modest or very little connection to any goings in the region, have sold off in sympathy. Gold, treasuries, and other risk-off havens have gained in value. Commodity markets have also reacted with Oil prices moving over $100 a barrel. European natural gas contracts moved up as much as 31% based on the news given Russia is a major supplier to Europe for the natural resource. As of close yesterday, Russian equites we’re down over 22% YTD. It is likely they will see continued pressure in the short-term as the US and EU allies weigh additional sanctions and actions. Globally currency markets are reacting as well. The Russian Ruble fells as much as 9% relative to the U.S. dollar and Ukraine suspended its currency operations under martial law.
How does this impact portfolios?
Most acutely, Russia is 3.29% of the Emerging Markets Index. It is important to remember the Emerging Market Index is a collection of countries with different economic and geographical realities. While the Russian invasion is most likely to hurt the country itself and their immediate neighbors, other countries may benefit. For example, Brazil has benefited from higher oil prices globally and if tensions keep prices up, it may continue to do so in the future. Brazil is 4.32% of the index today and is up 20% YTD. Additionally, companies outside of Russia may experience more nuanced impacts. For example, French car manufacturer Renault has a subsidiary in Russia and fell nearly 10% on the news. On the global fixed income side, Russia is a modest contributor to overall risk of the asset class benchmark.
Does this impact the Fed?
Central banks globally, including the Fed are in a difficult position. With interest to keep prices under control while not smothering economic growth, they are walking a fine line. Markets largely expect a 25bps increase from the Fed after its March 15-16 meeting. However, conversation has been drifting to a 50bps increase given recent headline inflation numbers. The invasion has a dual effect of adding fuel to the fire of inflation with higher energy prices but may provide the Fed aircover to move at the more modest pace of 25bps based on greater uncertainty. A 25bps increase is presumed to be the preferred path for the Fed. Futures prices that indicate the market’s “best guess” on what the Fed will do also reflect this change in sentiment as shown in the table in the attached document.
How have markets reacted to geopolitical shock historically?
An analysis from Truist Advisory Services shows that the S&P 500 has, historically speaking, recovered in a matter of months following a geopolitical shock, so long as the event itself didn’t lead to or coincide with a recession (please see table in the attached document).
How does the current situation change our outlook?
At this time, we are not changing our outlook or recommending any broad changes. While this is a very unfortunate humanitarian event, at this point it currently has limited global significance to broader themes built into our diversified portfolios or our long-term capital market assumptions. As of now, risk market expectations remain strong for full-year 2022. We will be keeping a close eye on the geopolitical events as they unfold and remain focused on monitoring inflation and monetary policy.
We entered this year believing that more volatile markets were in store and have positioned portfolios accordingly. We continue to recommend a broadly diversified portfolio as defense against unexpected situations. While a material headline event today with worsening developments possible, we hope that any long-term impact will be limited. Should the facts change, so will our opinion and we will make sure to update portfolios accordingly.
We urge clients to remember that our outlook is beyond the immediate term. Periodic market pullbacks are a normal occurrence in the context of long-term investing. We seek to allocate efficiently over an appropriate time frame for each client on an individual basis. Interestingly, the S&P 500 has historically bounced back faster from declines than what most investors might otherwise think, so long as the pullback is of a lesser extreme, i.e. less than a 20% decline (please see table in the attached document).
As always, should you have questions or concerns during this tumultuous time, please reach out, we are here to listen, talk and help where we can.