If ever there was proof needed that investors can’t predict what direction the stock market might go, last week offered it in spades. It seemed a foregone conclusion the markets would sell off with the Russian attack on Ukraine. Yet this did not occur in the U.S. markets and, in fact, they snapped back nicely. An investor who bailed out early in the week would have missed the positive activity on Thursday and Friday. Let’s also keep in mind the S&P 500 has still posted a gain of +16.1% since the end of February 2021 along with a nice gain of +10.5% by the DJIA (Dow). Even the NASDAQ is up +5.1% over the rolling 12 month period. So despite the negative activity in early 2022, the longer-term picture remains positive.
So what should we be thinking about this war across the globe? The direct impact on the U.S. economy and corporate earnings is likely limited, in our view. Trade between the U.S. and Russia is relatively insignificant, and Russia's economy is only the 11th largest, accounting for less than 2% of global GDP. For perspective, the German economy is almost three times larger, despite having half the population. However, Russia is a major commodities producers and exporter. Europe gets nearly 40% of its natural gas and 25% of its oil from Russia. Together with Ukraine, Russia accounts for about a quarter of global wheat exports. Thus, the primary risk is a disruption in the supply of energy and other agricultural commodities, which would cause prices to rise and drive inflation higher for a longer period.
Following the same playbook as with past geopolitical shocks, oil jumped to $100 a barrel for the first time since 2014. A sustained spike in energy prices would add to the current inflationary pressures, further hurting consumer confidence and leading consumers to cut back on spending. However, we don't think that $100+ oil prices will necessarily be the new long-term normal, as supply can possibly increase to ease some of the pressures. The U.S. appears closer to lifting sanctions on Iran's oil, President Biden mentioned that the U.S. is coordinating the release of strategic reserves with other countries, and U.S. shale producers could ramp up production, incentivized by the high prices.
The Russia-Ukraine conflict complicates central banks' efforts to tame inflation because it exacerbates the same problem policymakers are trying to address, at a time that they would normally ease policy to help growth. The silver lining is that central banks might delay (more likely the case in Europe) or slow their tightening process (a less likely chance for a 0.5% Fed hike in March), which could cushion the blow to financial markets.
Let’s try to put all of these current events into perspective: Corrections like the one equity markets are experiencing this year are uncomfortable, yet common. Since 1971 there have been 18 corrections without recession, with an average decline of 14.5% from peak to bottom over an average of 4.3 months. Historically, these sizable market pullbacks that took place within the confines of a bull market have been good times to add equities, with stocks rising 17% six months after and 23% a year later. So let’s not panic or lose faith in our ability to reach our financial goals over the long term. The ride is never smooth.