Just a quick note before we begin:
Our last bi-weekly review discussed what might happen in the financial markets should Russia decide to invade Ukraine. Unfortunately, the issue is no longer an “if” as Russian troops advanced on their neighbour on Thursday, February 24.
While we analyze the situation from a financial standpoint, our thoughts remain with the people of Ukraine and anyone affected by these latest attacks.
In the Macro
- Prices surge as investors fear sanctions against Russian energy
- Will the Federal Reserve hike interest rates during the crisis?
In the Micro
- Stock market performance during wartime
In the Macro
Prices surge as investors fear sanctions against Russian energy
For months investors have been watching the situation in Ukraine, fearing not only an invasion but sanctions on Russian energy in response. The threat of war has pushed oil and natural gas prices higher until they peaked on Thursday, February 24. Both Brent crude, the international oil benchmark, and West Texas Intermediate (WTI), the American benchmark, saw their value move above $100 per barrel. The last time we saw prices above this level was in 2014.
In the days since, oil prices have retreated as energy sanctions appear to be less likely, though not entirely off the table. Prices are likely to remain elevated throughout the conflict, especially with Russia being one of the largest oil producers in the world and the second-biggest producer of natural gas. According to BMO’s Senior Economist Art Woo, Russia supplies around 12% of the world’s crude oil and 17% of natural gas.
Sanctions against Russian energy would further decrease global supply and drive prices higher across the globe. TIME Magazine suggested that the European Union gets approximately 35% of its natural gas from Russia. If this were to be disrupted, prices could surge even higher. European consumers are already paying ten times more for natural gas than one year earlier.
With Europe purchasing approximately 72% of Russia’s natural gas, energy sanctions may still be an effective tool to get Putin to reconsider his military operation. It takes time for sanctions to have an impact, though, and given Europe’s dependence on Russian energy, the West is likely to suffer first. Some analysts even believe oil prices may surge to as much as $130 per barrel.
A statement from former President Barack Obama said it best: “There may be some economic consequences to such sanctions, given Russia’s significant role in world energy markets. But that’s a price we should be willing to pay to take a stand on the side of freedom.”
Will the Federal Reserve hike interest rates during the crisis?
Amongst the headlines of war in Europe, inflation remains an issue for many developed economies, including the United States. According to BMO’s Chief Economist Douglas Porter, rising consumer prices are “now such a heavy-duty risk that the Fed really has little choice but to proceed with hiking, even in the face of conflict.”
Before the invasion of Ukraine, analysts had expected the Federal Reserve could raise interest rates by as much as 50 basis points at their next meeting. While many agree there is no reason for the central bank to delay its first interest rate hike, the pace of increases could be slower. At the next meeting, they now expect a more cautious tone and a rate hike of only 25-basis points.
Source: RBC Wealth Management
According to RBC Wealth Management, war means “inflationary pressures are potentially stronger and more durable than pre-invasion, potentially raising pressure on long end rates.”
In the Micro
Stock market performance during wartime
In our last update, we touched on data from LPL Financial that showed all the major geopolitical events since 1941 and their impact on the S&P500. The information showed that it took the US index 43 days on average to recover from a sell-off related to a geopolitical event. While this still rings true, we are now in wartime and wanted to expand on how the stock markets reacted leading up to and following the invasion.
Prior to the attack, volatility spiked in the financial market. Investors moved away from riskier assets, such as technology stocks and cryptocurrencies, in favor of cash, bonds, and gold. On February 22, the S&P500 officially moved into a correction, falling more than 10% from its previous high.
Starting on Thursday, February 24, the day of the invasion, equities began to rally and continued to move higher the following day as well. As of market close on Friday, the Nasdaq ended the week 1.6% higher, with the S&P500 moving up 0.8%. Despite a weekly gain, the S&P500 is still in correction territory.
How is it possible that after months of tension and volatile stocks moved higher once the war began? According to BMO’s Chief Investment Strategist, Brian Belski, “history shows that the market recovers from ‘actual events’ very quickly.”
During times of war, it is possible to see stock prices rise. The below chart, created by the president of Armbruster Capital, suggests that equities have historically seen less volatility in returns during major wars.
In a special report on this latest conflict, BMO Economics points out that “if there is one lesson from looking at past geopolitical conflicts together as a group (and they are all different to be sure), it is that they usually prove to be noise in the bigger picture that is ultimately shaped by the economic and monetary policy cycles.”
RBC Wealth Management echoed the sentiment saying the equity markets will focus on economic and earnings growth after the initial fallout.
If we then focus on global growth rather than geopolitical events, it is normal for the stock market to see a correction from time to time. Pullbacks frequently happen, even during periods of economic growth. The sell-off from the past few months, whatever the reason for it, is nothing we have not seen before.
Source: RBC Wealth Management
There may be further volatility in the coming days, but we urge you to avoid making changes to your portfolio as a result. As the crisis in Ukraine continues to unfold, we maintain our recommendation to invest with the long term in mind.
As always, if you have any questions or would like to discuss further, please do not hesitate to reach out. Feel free to share with your friends and family too, as referrals are the best compliment we can receive.