This is a new installment in an ongoing series where Marc Bautis, Wealth Manager and Founder of Bautis Financial, comments on hot topics in the financial industry.
We’re about 10 days into the Russian invasion of the Ukraine, and I want to give some additional perspective of the grim situation and what could happen in the markets.
Possible Implications for Markets and Our Economy
Given Ukraine’s critical pipelines and Western sanctions on Russia, the crisis may lead to higher energy prices, which will trickle down to higher pump and heating fuel costs. Sustained price increases could hamper the Federal Reserve’s effort to control inflation. On Wednesday, Jerome Powell noted the highly uncertain Ukraine impact, but said rate hikes are still coming.
Extreme volatility, as we’ve already experienced, is very likely. Another correction (or even a bear market) is definitely possible. The market could also continue on the ascent upwards that we saw in 2020 and 2021. January and February of this year could just be a blip in the 10-year bull market.
What does history teach us about market reactions to geopolitical shocks?
History shows that stocks usually recover quickly from geopolitical crises. There is always the disclaimer that the future doesn’t perfectly match the past — but it often rhymes.
Let’s take a look at some examples from other invasions and wars.
Here’s the key takeaway: In the short-term, markets usually react badly. However, a year later, markets have historically recovered. During the Cuban missile crisis, the S&P 500 lost 6.6% over eight days. At the time, the world appeared to be on the brink of nuclear annihilation. The biggest decline occurred after the surprise attack on Pearl Harbor. The index shed nearly 20% in 143 days but managed to erase losses within one year of the attack.
Will they always? In every case? That’s impossible to say. But, a study of 29 geopolitical events since WWII shows a general trend toward short-term losses in the first weeks and longer-term gains over months.
A note: “geopolitical event” is a very antiseptic phrase for horrible things like bombings, wars, invasions, attacks and really fails to encompass the full cost in human misery.
How the war affects the U.S. and global economy will ultimately have the biggest impact for investors. What will happen to oil prices? How might sanctions play out? Could we see cyberattacks or a wider war that involves NATO? Will the invasion rein in the Fed’s apparent impulse to boost interest rates at an aggressive pace? These questions are difficult questions to answer.
At the same time, stiff sanctions against Russian banks and Russia’s Central Bank did not cause immediate tremors in U.S. markets.
“The U.S. and other Western economies have deployed a set of highly potent financial weapons against Russia with remarkable speed,” said Eswar Prasad, a Cornell University economics professor and former International Monetary Fund official.
From a financial perspective – and this is important – Russian oil and natural gas have not been sanctioned.
Stocks were priced for perfection heading into 2022. When stocks are priced for perfection and unexpected events occur, we typically see a reset. In this case, a more hawkish-sounding Fed and Russia’s aggressive posture toward Ukraine provided the perfect pretext for short-term traders to take profits.
While we have been due for a market correction, attempting to time such a pullback is all but impossible. There are those who have been calling for a correction for over a year and found themselves watching the major stock market indexes rise to new heights. Besides, if you want to time the market, you must be right twice to be successful — near the top and near the bottom. The smartest analysts haven’t figured out that equation, and they never will.
Longer-term, the biggest influence over stocks is the U.S. economy, the Federal Reserve, and corporate profits, or what we call the economic fundamentals. How the invasion affects consumer psychology will play a big role.
Are people going to avoid dining out, or, for that matter, skip the purchase of an appliance or a planned trip? It seems unlikely. The direct impact of Russia and Ukraine on the U.S. economy is quite limited. From December 15, 2021 to February 17, 2022, just 4% of the of S&P 500 firms that conducted earnings calls with analysts (earnings calls typically follow the release of an earnings report), cited the word “Ukraine,” according to FactSet.
By contrast, 72% of S&P 500 companies cited “inflation” over the same period. Indirect concerns might spring from oil prices and certain commodities Russia and Ukraine export.
Control what you can control. What is happening overseas is something you and I cannot control.