The Market Response to Russian Invasion of Ukraine

It feels callous to discuss the market impact of the Russian invasion, amid the human tragedy of people fleeing their home country in the first land war in Europe since WWII. But this is a market newsletter, and the invasion, like previous geopolitical shocks, is having a material impact on markets.

Perhaps the first thing to recognize about the Russian invasion is that it didn’t happen in isolation, meaning that all kinds of other things are going on.

While the Russian situation was on people’s radar earlier this year, the big story in the US was the decades-high rate of inflation and the shifting expectations towards how the Federal Reserve might respond.

The Russian invasion actually compounds that problem. Russia is the world’s third-largest oil producer and second-largest natural gas producer. Even without sanctions, we should expect disruptions to the global energy supply that will likely lead to higher prices. And, with sanctions, it’s reasonable to expect greater disruption and prices.

The higher oil prices will translate into higher inflation. Goldman Sachs estimates that for every $10 rise in the price of a barrel of oil, headline inflation increased by 0.20 percent.

While oil is likely to have the most impact, other commodities will be a factor too. Russia and Ukraine represent more than 25 percent of the global wheat market and are significant players in corn as well. Russia also controls half of the world’s palladium supply, which is used in cars and could add to the current supply chain problem.

The Federal Reserve sees all of this and recognizes that it has to raise rates, as noted by several Fed officials at the end of last week. Mary Daly of the San Francisco Fed, for example, said that she ‘did not see anything right now’ that would cause the Fed to leave rates at zero.

At the same time, the appetite for the Fed to raise aggressively has also waned, since it’s uncertain what the impact of the Russian invasion will have on stock prices and consumer sentiment that might affect spending. The appetite for aggressive Fed action seemed to be waning before the invasion anyway.

All of the commentaries that I’ve read, correctly say that it’s impossible to know where events go from here. Even the weekend has produced a flurry of news, including potential additional sanctions, aid for Ukraine’s defense, and fierce Ukrainian resistance.

While impossible to predict, it can be useful to look at how markets responded to previous geopolitical shocks. Last week, Vanguard produced a piece that said that geopolitical sell-offs are typically short-lived.

They analyzed more than 20 geopolitical shocks dating as far back as the Suez Crisis in 1956, and as recent as the 2016 Brexit vote and found that the average decline was typically less than 10 percent, and a year later, the S&P 500 was nine percent higher on average.

Interestingly, their analysis didn’t include 9/11, which was the biggest geopolitical shock for me in my life. They didn’t include it because it happened in the middle of the tech bubble burst and corresponding recession.

I think they made a reasonable choice in excluding it, but it illustrates the point that these things don’t happen in a vacuum – other events are at play too. Who knows what was happening besides the Suez Crisis in 1956 with earnings, interest rates, and the economy, which also illustrates the point that context matters.

Still, I think we can draw the conclusion from their research that as much as markets are hit by important outside factors, ultimately, the values are a function of fundamental factors like economic growth, inflation, earnings growth, interest rates, and valuations, among others.

Some of these factors were already an issue, as highlighted by the inflation discussion above.

Regardless, the recent events are a good reminder that we live in an uncertain world. Our approach today and for the past 20 years is to help clients find the appropriate asset allocation for their circumstances and emotional risk tolerance.

We routinely show what could happen to portfolios and then have to admit that we have no idea when those bad times will come, how deep they will be, or how long they will last.

But we also point to the long history of recovery and resilience in markets over sufficient time horizons and expect that the current events will fold into history like all of those that came before this one.

In other words, even though we didn’t and couldn’t predict that Russia would invade Ukraine, we’ve planned for this.