What the Russia Ukraine War May Mean for the Capital Markets (Article)
What the Russia Ukraine War May Mean for the Capital Markets
Since Russia’s invasion of Ukraine two weeks ago, the conflict has continued to intensify resulting in over 1.5 million Ukrainians fleeing to safety in bordering nations. The global community’s response has been to severely sanction Russia, cease doing business with the country, and supply Ukraine with food, fuel, and defensive munitions. Amidst a sea of diverse opinions and chaotic news flow, our focus remains on observing changes in securities prices across all manner of assets to assess the current impact and potential outcomes of this disastrous situation. The following areas, we believe, are key to monitor:
- Energy markets, oil and natural gas. European energy prices continue to be rocked by the uncertainties around supply. Brent Crude oil has moved speedily from $100/bbl to $123/bbl, closing in on its all time high of $139.83 notched in June 2008. Year-to-date, natural gas prices in Europe are up over 300% while the broad basket of commodities, as measured by the Credit Suisse Commodity Benchmark, is up almost 40%. We think this results in the global economy slowing down but not falling down. Worldwide, surging commodity prices will result in less consumer discretionary spending and businesses will face materially higher input costs. Yet, we doubt this commodity increase will cause a near-term recession, especially with the significant amount of global liquidity provided by the central banks in response to Covid-19.
- U.S. interest rates and the U.S. dollar. The yield on the ten-year Treasury has fallen to 1.74% from over 2.00% a few weeks ago. At the same time, the two-year Treasury bond has nudged higher to 1.54%. Though the yield curve has flattened, it remains slightly upward-sloping, a positive reality at present. The dollar has materially strengthened to levels like May 2020, at the height of the first wave in the coronavirus. We think the U.S. economy can weather this crisis. Though the economic growth profile of the globe is less robust than as recently as a month ago, the upward sloping nature of the Treasury curve points to growth, and the New York Fed’s probability of recession in the next 12-months for the U.S. remains low (6%).
- Equity markets. Year-to-date, the S&P 500 Index remains in correction territory (-11%) while European markets like Germany, Spain, and Sweden are down nearly 20%. The MSCI Emerging Markets Index is down 7%. Even with these declines, corporate fundamentals are largely intact. Earnings results are broadly encouraging with the vast majority of the companies in the S&P 500 beating consensus expectations indicating the economic momentum is robust. We think the future of Eastern Europe is indeterminate and poses further geopolitical risks – Russia’s power structure and military strength presents a potent combination threatening further mayhem. While capital markets are pricing in a regime change in Ukraine, they could also be signaling one in Russia. The strengthening dollar clearly indicates investor angst is growing in a short-term flight to safety.
For those with a higher risk tolerance / longer-term time horizon, consider:
Rebalancing. During times of large market dislocation, it’s worth considering rebalancing your holdings which in most portfolios would result in slight decreases in bond holdings and correspondingly small increases to risk assets like equities.
For those with a lower risk tolerance / closer to retirement, consider:
Focusing on Preserving Purchasing Power. Rising inflationary pressures and the potential for stagflation is increasing. Consider reducing international and domestic equity exposure and adding to commodities positions especially given the significant unknowns regarding global energy supply constraints.
Hedging Geopolitical Risks. With worst case scenarios looking increasingly probable, consider reducing international and domestic equity exposures and adding to longer duration fixed income bonds.
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Source: Morningstar. Past performance is no guarantee of future results.
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