Markets Update - Russian Invasion of Ukraine
Matthew M. Neyland
CFA, CAIA, Chief Investment Officer
Well, I mentioned before in my last video that there’s been a lot thrown at the financial markets this year that have really caused a lot of pain in the markets.
But now we’ve got Russia actually invading Ukraine, and that’s opened up a lot of geopolitical risks and potential outcomes. So I wanted to give you an update on what’s happening in the markets.
And my thoughts as far as the road ahead, the one thing that I looked at was going back in history when we have conflicts, you know, what has been the outcome in the markets?
What, what tends to happen? Well, there’s an old saying in the financial markets that you buy the rumor and sell the news, and that’s happened throughout a lot of these conflicts.
You can see in, in, on this graph here, where I went back and I looked at conflicts where the United States was actually involved militarily either in sending troops or through missile strikes.
So it’s not quite the same as it is now. So a little bit different, but just to give you an idea on kind of how the investors in markets have reacted to these types of conflicts.
And, and as I mentioned, the lead up or the rumor to the war, the conflict is where the market sell off as the uncertainty increases and the unknown increases.
And that makes sense. And then once the conflict starts really gets underway, you tend to see the markets recover over that period of time because of that, uncertainty is out of the way.
And the path ahead seems a little bit clearer not to, to path here is, is clear yet, but we will see how this all plays itself out.
But the other interesting thing is when I went back and I looked at all wars that have occurred and the impact on the markets during those periods of time, I looked at the impact in a lot of different sectors.
And what I saw was very interesting. One is that throughout the conflict markets tend to go higher. And that includes a lot of different ones, whether it be bond sectors or stock sectors, but the, I think the more interesting phenomenon is as the conflict went on the volatility in the markets decreased.
And that’s interesting as we roll through this conflict to see where things go and to see how things play out and not that the last two days are a good sampling of, of what’s happening, but the last two days are really been exactly following the path that’s happened before, you know, where the market sell off as the heightened uncertainty builds, but then once the conflict happens the markets actually start to recover and move higher.
So we, we saw that today that recovery today in the markets, but again, it’s a small sampling. I don’t want to draw any conclusions from that, but I think another important thing is to look at the duration of the economic impact and the market impact and a big thing here is how long can Russia really stand a, to, to stay in the game here?
In a sense because there is some economic pain that they’re facing. We know today that the United States and other countries have had a coordinated increase in the number of sanctions, and there’s other things that are going on the Russian stock market today fell the largest one day drop in history over 30% that as you can see in this chart brings the year to date drop to over 45%, which is pretty amazing.
And when you think about that, that means that when you analyze the Russian elite and a lot of Putin’s colleagues there, they’ve lost hundreds and hundreds of billions of dollars of wealth because of this conflict.
And so we’ll see how long they want to stay in the game because of that. Another thing that’s happened too, is that there’s been a lot of rumors about, oh, Russia is prepared they’ve without a doubt have increased their foreign currency reserves.
They also are an important trading partner for a lot of countries including European countries both for energy and agricultural and metals, but what’s also happened to affect that now is a ruble has been crashing.
And once the ruble starts crashing like that, that means their goods are more expensive across the globe, which isn’t going to be another break on their Condamine and, and also interest rates, interest rates have been a big influence because of the fact that bonds in Russia, D Russian denominated bonds have really taken a beating here over the last few days.
That means that the cost of borrowing for them has increased quite a bit. So it’s be another thing that’s going to hamper their economy.
The other thing I think is, is another one of these unintended consequences that can occur here when we had the pandemic hit.
If you remember, one of the things was a big issues with supply chains and that everybody was re-evaluating, you know, where they get their goods both from a country standpoint and a company standpoint.
I think that this is another unintended consequences it’s going to occur to Russia is that countries are going to look at other ways of getting the resources they were getting from Russia.
And that’s going to play out over time because it’s not easy to suddenly replace oil and gas and some of the metals that they produce, but I think that’s going to exacerbate that.
And also, I think it’s going to really exacerbate or increase the adoption of alternative energy sources across the globe where people are going to say, I don’t want to be held hostage to an energy situation.
So we’ll see how long Russia can withstand this pain in, in order to complete this invasion. Now the road ahead, where, where are things going economically?
As I mentioned in the prior video, that the number one thing, all eyes are on the fed, all eyes are on the central bankers across the globe because a big shift in policy is going on as far as, you know, going from reducing interest rates to raising interest rates.
If you look at the markets today, the pricing in the markets is anticipating at least six interest rate hikes in the United States, five in England or great Britain.
And one in Europe, I’ve never been in the camp that that was going to happen. I always believed that the economy and the a is going to gradually slow down the, the federal reserve and central bankers are going to be more willing to take their time because the type of inflation that they’re trying to fight is really more supply driven than demand driven.
So raising interest rates is not necessarily going to fix that, and they don’t want to risk a policy mistake here and push the economy into a recession.
So if that is plays itself out, as I think it will that’s going to be good news. Having interest rates not move up in a dramatic fashion not that they were but move up at all is going to help stock prices.
It’s going to help the bond market performance. It’s going to help a lot of asset classes. So it could be very good for second half of the year even beginning late second quarter of the year, or maybe even sooner here for, for market performance going forward.
I also think that the inflation story similar to what we’re talking about here, that that will continually get a lower as we go throughout the year.
And I think that makes sense from a lot of things because the supply is starting to get resolved and demand has slowed down a little bit as far as the both from a consumer level and from a corporate demand level, which will, will help that, that situation.
The other thing when I look at the economy, the economy is still on very strong footing. The fundamentals that drive the stock markets are very healthy corporate earnings, corporate balance sheets.
Even when you look at the consumer that consumer’s balance sheets in a sense, so their amount of their debt is, is very low.
So it it’s healthy. We look at a historical basis. So those are the underpinnings of, of a healthy market that helps with withstanding this type of big, dramatic global crisis now shifting to our strategy.
So, so what are we doing? What’s what’s happening within the portfolios, but as I always say, it really matters most what you do ahead of the conflict, as opposed to what you’re doing during the conflict trading in a conflict like this can be very dangerous.
From the standpoint you can be whipsawed, you know, similar to, as I mentioned that you’re seeing the last couple of days here, as far as the markets go.
But what we’ve done ahead of this case here is at the end of 2021, we increase the cash reserves in portfolios.
We also make sure, and we do this as a policy regularly is keep three months of cash reserves for any portfolios that are taking regular withdrawals.
That gives us a lot of flexibility on the trading side, because it D we don’t have to trade in environments like this.
We can be patient because we have a little bit of cash built up to meet any cash needs within the portfolios.
The other thing that we did is we added to the amount of hedging strategies within the portfolio, this not only buffers, downside risks, but it enhances income generation in the portfolios, both of which are been important through the first half of the year for limiting downside and from enhancing the overall diversification of the portfolios.
Another thing that I mentioned before is that all sectors have been hurt the, the start of this year and with all the uncertainty and, and regime and stimulus changes that are going on.
But an interesting thing has happened over the last couple of weeks is that investors now got to the point where they said, Hey, I can’t take it anymore.
And they’ve shifted some of their assets to safe havens, meaning some bond categories. So regular bonds, municipal bonds have been a place where investors have started to move dollars which has added to the returns of, of those categories.
So they’ve regained their status of safe havens. We’ll see how long that lasts, but it’s been another thing that’s really helped with the, you know, diversification and building of the portfolios to protect some of the downside risks, another thing that we’ve been doing, and, and we do this on a regular basis, but in you don’t always get environments like this.
We’ve been doing active tax loss harvesting. So that is a technique where we sell, if there’s any losses and we immediately buy back in the exact same day to maintain exposure to that sector or to that market.
So it allows us to be, it’s a tax efficient strategy. It improves the after-tax return of portfolios. And it is something that we look at throughout time.
The other thing that’s happened here with all this volatility in the market, it creates opportunities both from a trading standpoint and from a long-term positioning standpoint because it changes the pricing and the entry point in different areas that we’ve been looking at.
So we’ve been ramping up our review of, of places that we thought weren’t quite there from a pricing standpoint, that we can make adjustments to prepare the portfolios for, for what’s next.
So what are the, what are the main takeaways here? We know when there’s headline risks like this global risk, like this that occurs or economic risks that occur like this, it does create that headline risk and the headline risk leads to dips and rebounds in the markets, the information flow through social media and other sources and the way the markets are traded now with a lot of computer generated trading going on you tend to see that happen quite a bit nowadays and, and get and whips on, get overdone.
As I said, at points in time, this is just a, when we look back at history, whether it applies this time, we don’t know or not, but history shows that these types of conflicts that the markets can move higher.
And then the interesting phenomenon that I mentioned that volatility can decrease throughout a conflict. And when we moved to the economy the economy is still very healthy, both of us and overall, globally here.
So we’ll see how this plays itself out. Whereas you look at the Russian economy, as I mentioned before, it’s been stagnant for a while and they have done a poor job of handling the, the vaccine.
So that conflict between economic factors also may play into how long this conflict lasts. And then the other thing as I mentioned, this is just you know, history is just a guide.
But the markets have generally had limited impact is particularly the U S markets have had limited impact here. With these conflicts, both from an economic standpoint and from a market standpoint, the duration of the impact has been narrow.
So we’ll see how this plays itself out. But I wanted to share those thoughts. If you have any questions, please feel free to reach out to me.
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