U.S. stocks surged today led by financial and tech shares which were rebounding from several down days. Oil prices pulled back sharply after fanning inflationary fears, and investors gauged developments in the Ukraine crisis. The S&P 500 posted its biggest one-day percentage gain since June 2020, while the Nasdaq tallied its biggest rise since March 2021. In addition, global oil prices posted their biggest plunge since the early pandemic days nearly two years ago.
Against this backdrop, a wide range of potential scenarios and outcomes are possible. Rather than play the “what-if” game, let’s focus on the potential implications of the current environment across assets classes.
The rapid escalation of the conflict between Russia and Ukraine has significantly shifted investor sentiment. Since Russia’s invasion, there has been a noticeable setback in key financial markets, and volatility has ramped up in global markets. Furthermore, the conflict between the two bordering countries has had the effect of ushering all three of the major U.S. Indices (the Dow, the S&P 500, and the Nasdaq) into correction territory. Based on these critical events, investors should assess the geopolitical landscape before making any investment decisions.
It is important to note that we are proponents of long-term investing. In periods of uncertainty, it is easy to get distracted by headlines. Investors who are distracted tend to make poor decisions which can be costly and undermine goals. In short…stay the course.
However, as your trusted advisors, we are primarily concerned with helping investors assess the long-term market implications of sudden and drastic market declines. While there are certain impacts that are relatively clear, there may be other less obvious impacts that need to be assessed. Upon completing an analysis, a possible conclusion may be corrective action is necessary to “right” a wayward plan. Thus, it is critically important to remain alert and prepared during periods of uncertainty. On the brighter side of things, short-term fluctuations and volatility can also uncover meaningful investment opportunities.
The war between Russia and the Ukraine has been the main driver of the recent surge in oil and gas prices. To the extent the economic sanctions imposed on Russia become even more restrictive, the sanctions will put pressure on a stressed global supply chain, which will inevitably lead to a rise in the price of commodities. Both Russia and Ukraine are key players in global wheat exports, and Ukraine is one of the leading exporters of corn. The Russian invasion has already clouded the prospects of corn exports from the Ukraine. Exhibit #1 shows the potential detrimental effects of the war on Ukraine’s corn exports. (See Exhibit #1 – Output Worries -Ukraine)
Combining the oil and gas price surges with the additional hits to agricultural and intermediate supplies exacerbates global supply shock which is already at heightened levels.
The Kremlin has accused the United States of declaring economic war on Russia and has put Washington on notice that it is considering a response to the ban on Russian oil and energy. Russia’s response to economic sanctions could prompt an increased risk of inflation. Specifically, their response is likely to include the disruption of critical food and energy commodities which would certainly have an inflationary effect. Higher inflation could serve to give central banks further impetus to accelerate the tightening of monetary policy.
On the other hand, there is a chance interest rate hikes could be delayed to buffer against economic uncertainty. Aggressive rate hikes by central banks do nothing to alleviate the pass-through of higher energy prices. For central banks, it’s a double-edged sword. Either they accept higher inflation or they destroy economic activity to contain it.
Inflation tends to erode real returns, and rising interest rates by central banks tend to negatively impact bond pricing, creating an offset of sorts for fixed-income investors. Generally, increases to policy rates tend to be driven by an economy that can sustain higher rates. If central banks sense a vulnerability in the economic environment, they may act conservatively and decide to pause interest rate hikes.
Historically, traditional fixed-income would benefit from a pause in rising interest rates. However, in recent years, traditional fixed income as an asset class has had a diminished ability to act as a portfolio diversifier, even in a low interest rate environment. Therefore, in our view, assuming there is a pause in rate hikes, replacing traditional fixed income with non-traditional fixed income allocations such as private credit, floating rate bonds, and emerging market debt makes the most sense.
The war between Russia and Ukraine has certainly had a meaningful impact on global markets but it’s not the only factor. The Fed’s promise to start raising interest rates, runaway inflation, and a challenging corporate earnings season have also weighed on investor sentiment. In fact, all of the aforementioned factors have contributed to shifting the power dynamics of the best performing asset classes in 2022. This past decade’s big winner, U.S. large-cap equities, has been the worst performing asset class year-to-date. Interestingly enough, non-U.S. equities have out-performed U.S. equities and to no surprise, oil and gold respectively, have been the top performing asset classes.
Past performance is not a reliable indicator of current or future results. Indexes are unmanaged and do not account for fees. It is not possible to invest directly in an index. Sources: BlackRock Investment Institute, with data from Refinitiv Datastream as of March 3, 2022. Notes: The two ends of the bars show the lowest and highest returns at any point this year to date, and the dots represent current year-to-date returns. Emerging market (EM), high yield and global corporate investment grade (IG) returns are denominated in U.S. dollars, and the rest in local currencies. Indexes or prices used are: spot Brent crude, ICE U.S. Dollar Index (DXY), spot gold, MSCI Emerging Markets Index, MSCI Europe Index, Refinitiv Datastream 10-year benchmark government bond index (U.S., Germany and Italy), Bank of America Merrill Lynch Global High Yield Index, J.P. Morgan EMBI Index, Bank of America Merrill Lynch Global Broad Corporate Index and MSCI USA Index.
What does this mean for investors? Equity markets will likely carry sector dispersion and are unlikely to be impacted equally. Thus, there will be short-term tactical plays to consider such as allocating dollars to the energy and/or specific commodities. Moreover, the S&P 500 Index’s recent slide into correction territory has led to improved entry points, particularly for U.S. growth stocks. This is especially true for long-term investors seeking to deploy cash and willing to tolerate additional near-term market volatility. As witnessed today, the Nasdaq experienced its best day in 1 year, up 3.59%.
Looking back through prior geopolitical events, history shows that long-term investing, even during a crisis, often gives investors the highest probability of investing success.