We wanted to share some perspective on the situation in Ukraine and what could happen in the markets. If you’ve already heard enough about the crisis and don't care to absorb any additional information on the subject, then scroll down to the bottom to hear an interesting discussion on how people may be hard-wired for optimism.
The invasion of Ukraine is a serious and scary escalation in tensions between Russia, Europe, and the United States.
Before we dive in, let's take a moment to pray for the Ukrainian families who are suffering and dying as well as the Russian families who will suffer from the sanctions, the instability, and the severe economic damage to their economy. And pray that diplomacy will prevail to end this crisis.
What are some possible implications for markets and our economy?
Given Ukraine's critical pipelines and Western sanctions on Russia, the crisis may lead to higher energy prices, which could trickle down to even-higher pump and heating fuel costs.(1) Sustained price increases could hamper the Federal Reserve's effort to control inflation. We continue to keep an eye on inflation, as we’ve written in the past back in May and June last year.
What could happen in markets? Extreme volatility is the likely outcome, as we've already seen so far. Another correction or even a bear market is also possible.
What does history teach us about market reactions to geopolitical shocks?
History shows that stocks tend to recover relatively quickly from geopolitical crises. With a simple disclaimer that the future doesn't perfectly match the past — it sometimes rhymes. Here are a few examples from other invasions and wars:(2)
Here's a potential takeaway from the graph: short-term, markets tend to be very unpredictable. However, a year later, (shown by the tall dark bars) markets can recover. Do they always recover? No! But, the larger study of 29 geopolitical events since WWII shows a general trend toward short-term volatility within the first month and longer-term gains.(2)
When we use the term "Geopolitical event" we are using a very antiseptic phrase for things like bombings, wars, invasions, and other horrific attacks, and it really fails to encompass the full cost in human misery.
Our greater concerns…
When you combine what’s happening in Eastern Europe with our current inflation and extremely high asset prices, you have a combination of things that could lead to a significant market correction.
U.S. consumer prices rose 7.5% in January, the fastest pace in four decades, causing a rare simultaneous loss for both stocks and bonds. A Bloomberg index tracking a 60-40 portfolio of stocks and bonds has declined 6.7% this year, generating the worst annual return since 2008. While this sounds like a big deal, it’s minor in comparison to the equity market returns we’ve seen over the last thirteen years. And the correction that we saw in March of 2020 was so short-lived that many people have forgotten what it’s like to see 20% of their portfolio vanish in a six-week period.
Our concern today is the combination of these factors and how small tipping events can cause investors to run for the doors and exit risky assets. When that happens, there are very few places to hide.
The bottom line is that we cannot predict what will happen next, but we can assess the market and the risks as additional information comes to light.
And we can focus on what we can control: Our actions and reactions, and our strategies for uncertain times.
Looking ahead, we can expect more volatility, more down days, and possibly even a bear market in some areas.
So prepare for the heightened volatility to continue until there is a resolution with Ukraine, and take a few minutes to hug the people you love while being mindful of the needs around us. Please reach out if we can address any questions you have.
P.S. Tired of war and bad news? Need a break? I've got an interesting TED talk for you: The Optimism Bias.
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