On February 24th, we sent out a letter to our clients outlining our thoughts on the Russian invasion of Ukraine as it relates to financial markets. Now that some time has passed, we would like to circle back to provide an update.
Rather than Russia dragging the global economy down with it, corporations, governments, and individuals are instead taking steps to decouple themselves from Russia. For companies like Apple, where Russia makes up less than 1% of revenues, decisions to halt doing business in the country came very quickly. For others like McDonald’s, where Russia accounts for roughly 9% of revenue, the decision was slower but made all the same. While losing any percentage of revenue has a cost to investors, companies that have failed to act have seen backlash from consumers online and at the register. As a result, we would expect that most investors will be understanding, if not outright supportive, when companies report these results and update their earnings estimates.
As expected, there has been some disruption in markets where Russia and Ukraine play larger global roles. These include wheat, corn, neon used in semiconductors, palladium used in catalytic converters, and, perhaps most importantly, oil. Semiconductors and autos were already experiencing supply shortages prior to the conflict, and the current situation will certainly extend the duration of those shortages but is not exactly a paradigm shift. As for oil, the sharp increase in prices will have knock-on effects on demand. With fuel usage increasing as people return to their office commutes and take spring vacations, there is a risk that these cost increases outpace wage gains and cut into discretionary spending. That said, as we noted in our initial letter, the United States government can and has released some of its strategic petroleum reserves, warmer weather will ease some of the problems that winter weather imposes on production and demand, and the potential for a new U.S.-Iran deal could make more supply available. While any increase in supply from OPEC is unclear at this time, the United Arab Emirates announced today that they favor production increases and will be encouraging OPEC to consider higher production levels. In the meantime, although a small part of the market, it should be noted that higher oil prices also directly benefit the stocks of publicly traded energy firms in our clients’ portfolios. Over the longer term, the world will continue to pivot towards more renewable energy sources and Europe will decrease its dependence on Russia for its energy needs. The EU is currently considering a massive bond offering to fund spending on energy independence and defense spending.
As of the writing of this note, following the Russian invasion, the price of a barrel of crude oil has jumped by about 25% since our initial correspondence. However, it is important to put some historical context around the impact on consumers. According to FS Insight, at $130 per barrel today, gasoline expenditures represent about 3% of consumer wallet share. This compares to 4.5% of wallet share in 2008, when oil spiked to $140 per barrel, and 6.5% of wallet share in 1980, when oil rose to $39.50 per barrel (a significant amount at that time). The S&P 500 Index is slightly higher since the initial invasion of Ukraine, and while this represents a smaller impact on client portfolios than some headlines may indicate, this is a fluid situation and market volatility remains elevated. Moving forward, market participants will only gain clarity in understanding the situation and how it will unfold, further reducing uncertainty and helping the market find a floor.
Finally, as we have mentioned before, the outlook for the domestic economy remains positive. Jobs are plentiful, consumers have low debt and high savings, businesses have significant cash on hand, and the Omicron variant is fading away in the United States. The fading of Omicron and the return to normal as states across the country remove restrictions is a major economic event that will support future growth.