We are reaching out to provide some thoughts on the situation in Ukraine given last night’s events, particularly in relation to financial markets and your portfolios. Stocks have traded lower on these tensions in recent weeks and are down again today following Russia’s military escalation.
Markets hate uncertainty, as it makes it impossible to accurately model out future expectations. We have seen the market selling off in the weeks leading up to last night’s events, as investors were already worried and attempting to gauge the likely outcome given the range of possibilities. While this is not the outcome anyone was hoping for, it does provide some clarity. As a result, much of the Ukrainian conflict may already be priced into markets. In fact, historically speaking, the moment of invasion often coincides with the market bottom. We cannot say with certainty that the market will not be down in the coming days or weeks, but in the 1991 Gulf War, 2003 Iraq War, and even the 2014 Crimean crisis, the initial intervention coincided closely with the market bottom.
As we move forward, oil prices and commodities markets will be directly affected. Oil prices, which were already moving higher prior to the conflict, have shot up given the size of Russia’s oil and gas production. While higher prices at the pump are a headwind to consumers, the U.S. is well-equipped to counteract this. The U.S. can utilize its national strategic petroleum reserves in the shorter term to ease supply constraints, while rising onshore production and a pending Iran deal should further free up supplies if and when an agreement is reached. Unlike the U.S., Europe is not as energy-independent. European and American allies may also place new sanctions on Russian oil exports, which could further constrain supply. Still, spring is coming and warmer weather should help to mitigate some of the worst supply shortage effects. Longer term, these events provide a painful but necessary opportunity for Europe to reassess its energy dependence on Russia.
More broadly, recent events do not materially impact the outlook for U.S. GDP growth, which continues to look strong. Corporate earnings are still very positive and interest rates will remain at historically low levels even after the Federal Reserve raises rates this year. The individual consumer is in good shape as well, with savings and debt levels, delinquency rates, and unemployment data all coming in favorably. As the Omicron variant recedes and we continue to return to normalcy, we expect the domestic consumer will still be ready to go out and spend.
In moments of market turmoil it is important to highlight the role of fixed income in our client portfolios. Bonds do not receive the media coverage of the stock market, but they are a significant portion of most of our clients’ portfolios. As investors have pivoted to safer assets, bonds have seen inflows. This pushes their yields lower and, in turn, their prices higher. While bonds may lag equities in a major up-year like 2021, they provide an important source of stability in times like this.
Prior to current events, one of the other major factors weighing on the market was the Federal Reserve’s impending interest rate increases. In light of recent geopolitical escalations, the Fed has the ability to adjust and maintain a more accommodative policy position if it so chooses. We would not expect the Fed to abandon its plan for rate increases altogether, especially with inflation still high. However, the central bank does have the ability to make a more dovish pivot to support the economy if it so chooses.
As for our positioning and where your portfolios stand, we are in a relatively strong position to weather the current environment. We have long preferred the domestic market over European and other international markets, and our positioning remains strongly tilted towards domestic markets. Additionally, we recently rotated assets into value, thereby increasing underlying exposure to energy, consumer staples, and other areas that should better withstand these escalating tensions. Finally, we made a targeted decision to limit our exposure to small-cap stocks and companies with limited profitability. These types of firms, which will also struggle more when interest rates rise and borrowing costs go up, tend to have smaller emergency reserves and less pricing power, making them less attractive in this situation.
This situation in Ukraine is one that we will continue to monitor closely as it develops. We feel positive about our positioning heading in, and will continue to make adjustments as the facts on the ground change to ensure that your money is best positioned to both withstand any downturn and capitalize on the inevitable market recovery. As always, we thank you for your trust.
Ken Schapiro, CFA®️️
Condor Capital Wealth Management