Economic Flash: Ukraine's Conflict Becomes the Center of Attention

March 7th 2022

US Economy: Inflation worries.

Even though it wasn't at the blazing rate of 2021, the US economy continued to grow in the first months of 2022. Inflation and labor shortages continue to be a problem even as the Omicron variety of Covid fades away, and the Russia/Ukraine crisis adds to the pressure.

US Stocks: Volatility surges.

There has been a two-year high in stock market volatility in the United States because of a possible new Cold War with Russia. During the month of February, the only S&P 500 sector in positive territory was energy (+7.1 percent), while tech (-4.9 percent) and communications (-7.4 percent) were the worst performers.

Foreign Stocks: Russia sanctioned.

Despite the strong dollar and an approximately 30% drop in the Russian stock market on the last day of February, international stocks outperformed US equities. A number of restrictions have effectively rendered Russian equities "uninvestable," and they are no longer included in major global indexes.

Fixed Income:

Inflation fears pushed the 10-year US Treasury yield to a high of 2.1 percent before it dropped to 1.8 percent as investors sought safe havens following the Russian invasion of Ukraine. Due to lower interest rate sensitivity and geopolitical protection, municipal bonds have outperformed taxable bonds so far this year.

Real Assets: Commodities squeeze.

Concerns about rising inflation pushed commodity prices upward. Oil (+9.5 percent) and agricultural commodities (+8.9 percent) accounted for the bulk of the gains in February. Infrastructure stocks beat wider market portfolios, but their performance was somewhat negative.

Our Take

When it comes to market analysis, there are those months where it seems as though nothing jumps out. That's not the case this month. The Russian invasion of Ukraine has quickly overtaken concerns about inflation and a more positive Covid-19 outlook. With an eye on altering the regional power balance and reasserting Russia's political and economic dominance, Russian military have advanced forcefully into Ukraine in the previous several weeks. In reaction, Western nations have drafted an unprecedented array of economic and financial penalties against Russia, but have opted not to physically engage in the conflict.

A drawn-out war with no clear winners is possible because of these terrible conditions. Investors have come to realize the increasing unpredictability, and this is reflected in the volatility of financial markets. While we at Aldwin Callen aren't geopolitical experts, we can recognize the conflict's anticipated short-term economic effects and put it in context over the long run.

The western sanctions may or may not have an effect on the length or course of the conflict, but they are very guaranteed to cause short-term significant disruptions in the global supply chain, particularly in the food and oil commodities markets. The interruptions are expected to stoke the flames of inflation that have already been started in the United States and throughout the world. Investors have returned to US Treasuries, driving yields lower and undermining the story of increasing US interest rates in the financial markets.

What We’re Doing

Our experience as long-term investors and wealth planners has given us the opportunity to guide customers through a range of market shocks including war, the financial crisis, and pandemics to mention a few. When market volatility feeds investors' emotional and cognitive biases, we depend on our collective expertise and market history to give perspective. Since the 1970s, geopolitical market shocks have tended to be short-lived, even if each battle is unique and this one has the potential to reshape the face of Europe. That's what we desire for the people of Ukraine as well!

When we did our first re-balancing in 2022, it was to ensure that client portfolios maintained an appropriate risk-return profile, whereas now we are doing it to top up equity allocations (where clients are underweight or have excess cash) because market selling may be creating a disconnect between prices and long-term fundamentals.

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