- A quick recap
- How did we get here?
- But how does it affect the market?
- Market volatility due to rising oil prices and sanctions
- What Are the macro and market implications of the Russia-Ukraine crisis according to JP Morgan?
- Global equities
- US economy still grows despite high inflation
- According to Fidelity U.S. investors should not be discouraged by market volatility
- A word for from Nobel Laurette Richard.H. Thaler to conclude our report
- Diversify with low-cost index funds
- Asset allocation and the risk you can handle
A quick recap.
The crisis in Ukraine have been covered by the global media more closely than any other conflict that has scorched the Earth in recent times or the ones that are ongoing parallelly in the middle east and elsewhere. We are not going to argue the morality of such uneven coverage of human suffering mostly by western mass media but since the war is broadcasted almost in real time from Ukraine, most of us are aware of the time line of events leading up to the war and the crisis that’s unfolding post the invasion every minute of the day.
I will still include a quick recap for the uninitiated or if you are a dairy farmer in the picturesque Swiss alps and obviously have better things to worry about than the stench of what some western experts are calling “The worst conflict in Europe since the second World war”.
How did we get here?
Tensions between Ukraine and Russia have been brewing for a long time, ever since the annexation of the Crimean Peninsula, the colored revolution, and eventually Ukraine expressing its Interest to Join NATO. Russia amassed a large number of soldiers along the border and threatened to invade unless America provided written guarantees of Ukraine not joining the alliance. Those guarantees never came and Russia invaded its neighbor sparking a major humanitarian crisis that has dragged on for more than a month. Russia became the most sanctioned country in the world and an estimated 6.5 million people have been displaced in Ukraine. On the 29th of March, both sides met for peace talks and seem to have made real progress with Ukraine willing to discuss neutrality and Russia announcing a drastic scaling down of its operation in the West.
But how does it affect the market?
As Dirk Hofschire of Fidelity’s Asset Allocation Research Team says, “In general, these types of crises tend to only have a significant and lasting impact on global financial markets if they have a sustained macroeconomic impact on major economies.” While Russia’s economy ranks as the world’s 11th largest, according to the International Monetary Fund, at only 1/20th the size of the US and 1/15th the size of China, it is likely not big enough by itself to affect global markets or economic growth, even if it suffers significant economic damage as a result of sanctions against it by the US and Europe.
Still, because Russia is also the source of 10% of the world’s energy—and nearly 50% of the energy consumed in Europe—the conflict does pose risks beyond the 2 countries’ borders including higher energy prices and increased financial market volatility.
Market volatility due to rising oil prices and sanctions
Investors fear rising oil prices could supercharge inflation, eating away at consumer budgets and corporate balance sheets while tossing a wet blanket over the economy. Rising oil prices “are contributing to investor concerns that what could have been a transitory rate of inflation might be sticking around longer than anyone anticipated,” said Wayne Wicker of Mission Square Retirement. “Growth could be severely impacted.
Jeffrey Roach, chief economist at LPL Financial, pointed out in a note to investors that the long-term impact to U.S. businesses will probably be fairly small as Russia accounts for only about 1 percent of U.S. imports. But he warned of significant “downside risks” if the conflict extends ongoing inflation and supply chain problems.
What Are the macro and market implications of the Russia-Ukraine crisis according to JP Morgan?
According to a recent report by JP morgan there will be a significant impact on the market due to the ongoing crisis, let’s take a brief look at what the article says.
The risks to global growth posed by the Russia-Ukraine conflict are materially altered by the launch of a full-scale invasion. So far, as of March 18, we have revised down our 1H22 global GDP growth forecast by 1.6%-pts at an annual rate, a drag that leaves global growth at 2.3% annualized, dipping below potential. We have raised our forecast for 1H22 global CPI annualized inflation to 7.1%, a multi-decade high, and a 3.2%-pts annualized upward revision to our 1H22 inflation forecast. “The magnitude of the shock and the nature of these reverberations remain highly sensitive to the uncertain path that the conflict travels but recent events are prompting downward revisions to growth and upward revisions to inflation forecasts,” says Chief Economist Bruce Kasman.
The Russia-Ukraine crisis will slow global growth and raise inflation as global growth risk is linked to Russia energy supply disruption. J.P. Morgan research continues to forecast a synchronized monetary policy tightening cycle due to healthy demand and rapidly tightening supply point that to continued inflationary pressures. Russia accounts for well over 10% of global oil and natural gas production. While risks remain skewed to the upside, our baseline view is that the price of Brent crude will remain close to $110/bbl through midyear and that European natural gas prices will hover at about €120/MHw. Curtailing Russian energy supplies further could produce a sharp contraction in its crude oil exports to Europe and the U.S. of as much as 4.3 million barrels per day (mbd). It is hard to know the true extent of the decline in Russian oil exports with our estimates in a wide range of 1 to 3 mbd. Russia exports 4.3 mbd to the U.S. and Europe. Under the worst case scenario of a full ban, assuming the drag fell entirely in the first half of 2022, it would subtract 3% annualized from global GDP and add 4% annualized to the global consumer price index (CPI). According to J.P. Morgan’s Global Economics team, if this remains solely a negative supply shock and if the price of oil reaches $150, the hit to global GDP growth would be 1.6%-pt based on its general equilibrium model.
J.P. Morgan Global Research outlines initiatives under way to address the shortfall of a shut off in Russian oil exports:
On March 1, the United States and 30 other member countries, supported by the European Commission, agreed to collectively release an initial 60 million barrels of oil from strategic petroleum reserves, which could be increased further.
The International Energy Agency’s 10-Point plan presented on March 3 aims to reduce the EU’s reliance on Russian natural gas and sets out measures that could be implemented within a year to reduce Russian natural gas products.
The European energy security policy released on March 8 includes steps to move away from Russian dependency on energy, focusing primarily on reducing dependency on the gas markets.
The prospects for a nuclear agreement with Iran are rising. J.P. Morgan Research forecasts a deal in which Iran ramps up oil production by close to 1 mbd over the course of the year.
A mild winter has reduced imbalances in the European natural gas market and inventories have increased.
The Russian economy is headed for a deep recession and the imposition of capital controls. While there is some room for Russia to use its gold reserve and divert trade to China, Russia’s financial system is set to come under enormous stress as it will struggle to meet its financing obligations despite running a current account surplus. Downward pressure on the ruble and capital flight have pushed the central bank of Russia to raise rates dramatically and impose capital controls. J.P. Morgan Research forecasts that Russia’s economy will contract 35% quarter-over-quarter and seasonally adjusted in the second quarter, and for the year experience a GDP contraction of at least 7%. Inflation could end the year at around 17%, up from 5.3% forecasted before the crisis, with risks skewed heavily to the upside due to ruble depreciation and import shortages.
Global equities
The Russia-Ukraine crisis is a low earnings risk for U.S. corporates. However, an energy price shock amid a central bank pivot focused on inflation could further dampen investor sentiment.
Domestic Russian banks, followed by European banks with local legal entities in Russia, are the most exposed to risk resulting from sanctions.
U.S. companies have low direct exposure to Russia (around 0.6% for those in the Russell 1000 index) and Ukraine (<0.1%) based on disclosed revenues. Indirect risks could be more substantial, including:
Slower global growth and consumer spending due to higher oil and food prices
Negative second-order effects through Europe
- Supply chain distortions
- Credit and asset write-downs
- Cybersecurity risks
- Tightening monetary policy
Tightening monetary policy remains the key risk for equities as central banks grapple with inflation expectations. Policymakers may also consider additional fiscal stimulus such as a U.S. gas tax reduction.
Selected emerging market (EM) equities, particularly commodity exporters, should outperform amid a combination of higher rates and energy prices. Energy and materials, and Middle East and North Africa/Latin America would likely be the biggest beneficiaries, while healthcare and real estate stand to lose the most
European miners should see higher commodity prices due to supply dislocation of Russia-centric commodities. Palladium is the most exposed commodity, with Russia accounting for around 45% of total global production – prices are up around 65% since mid-December 2021. Russia accounts for >10% of global supply of diamonds, platinum and gold, while Russia and Ukraine combined account for in the region of 35% of EU-27 steel imports.
US economy still grows despite high inflation
Besides raising the likelihood of market volatility, the invasion is likely to add to inflationary pressures by disrupting exports of oil, natural gas, and wheat from Russia and Ukraine and raising prices.
The impacts of the conflict are likely to vary depending on geography. Europe—and particularly countries such as the Baltic states and Poland—are likely to experience more difficulties than countries that depend less on Russia for energy. Russian gas is a major source of winter heating in Europe and already spiking prices have hurt European households and businesses. Western Europe, particularly Germany, also has no easy alternative source of energy to replace Russian natural gas.
Hofschire says that the Russia-Ukraine conflict adds uncertainty about the strength of the economic expansion in Europe. While that injects some uncertainty into the global outlook, he says, the US economy appears relatively insulated from the conflict. For individual investors and consumers in the US, the effects will most likely take the form of additional inflationary pressures due to higher energy prices.
According to Fidelity U.S. investors should not be discouraged by market volatility
Despite geopolitical risks, US investors should not lose sight of the long-term opportunities that international stocks may offer. Indeed, Hofschire’s team expects international stocks to outperform US stocks over the next 20 years. Those expectations partly reflect the fact that US stocks have risen more than those of other countries over the past 2 years and US stock valuations are now high by historical standards.
Diversification and professional management can help manage short-term risks while pursuing long-term rewards. As Naveen Malwal, institutional portfolio manager with Fidelity’s Strategic Advisers LLC, explains, “We hold stocks and bonds across many different regions, countries, sectors, and industries. One result of our diversified approach is that our clients generally have very little direct exposure to investments in Russia, and even less exposure to investments in Ukraine. That level of diversification can give investors some peace of mind in the face of geopolitical events.” Or as Bridges puts it, “My view, as the old geopolitical guy, is to take the long view. Just stay focused and don’t be afraid.
A word for from Nobel Laurette Richard.H. Thaler to conclude our report.
NY times recently conducted an interview with Richard.H.Thaler who is an American economist and the Charles R. Walgreen Distinguished Service Professor of Behavioral Science and Economics at the University of Chicago Booth School of Business. In 2015, Thaler was president of the American Economic Association.
Thaler is a theorist in behavioral economics who has collaborated with Daniel Kahneman, Amos Tversky, and others in further defining that field. In 2018, he was elected a member in the National Academy of Sciences.
In 2017, he was awarded the Nobel Memorial Prize in Economic Sciences for his contributions to behavioral economics. In its Nobel prize announcement, the Royal Swedish Academy of Sciences stated that his “contributions have built a bridge between the economic and psychological analyses of individual decision-making. His empirical findings and theoretical insights have been instrumental in creating the new and rapidly expanding field of behavioral economics.”
I found the following points made by him interesting on how to think long term and how to diversify your portfolio even when the market currently is “Going Nuts”.
Diversify with low-cost index funds
When you’re really ready to invest, use low-cost index funds as your core holdings. Most people should plan on investing for decades, even if you’re entering retirement, Professor Thaler said.
“People in their 60s these days have many years of life expectancy,” he said.
I’m in my 60s and betting on my own longevity, investing regularly in the stock market as well as in bonds. I’m also following a recommendation that appeared in a Thaler column in 2011: doing whatever it takes to delay Social Security until I’m 70. “Waiting is the best investment you can make,” he reminded me.
Beating the market consistently by picking individual stocks or bonds is rare, especially after fees. It’s not impossible: Warren Buffett did it for years, but even his returns faltered, and that great investor recommends holding an S&P 500 index fund and Treasury bonds as core retirement holdings.
Despite wars and trade conflicts, markets are global now, so holding global stock and bond funds is probably the best approach.
Asset allocation and the risk you can handle
Figuring out how much to hold in stocks and how much in bonds is the next step. There’s no one-size-fits-all answer.
No risk, no return, is an old investing adage. Stocks historically have returned more than bonds precisely because there is more risk in owning them.
Historical returns provide no guarantee for the future, but they may serve as a guide. Vanguard posts returns for nine stock-bond portfolios based on U.S. index funds, and they are informative. From 1926 to 2020, for example, the worst year for the S&P 500 stock index was 1931, when it lost 43.1 percent; the best was 1982, when it gained 54.2 percent. The worst year for the pure bond portfolio was 1969, when it fell 8.1 percent; the best was also 1982, with a gain of 45.5 percent.
Stock and bond mixtures fell somewhere between these extremes. My portfolio is about 60 percent stock and 40 percent bonds. Find an asset allocation that works for you
If the current stock downturn is already ruining your sleep, you may hold too much stock. But try not to let the news get to you. You’re in this for the long haul. Don’t sell just when you’re worried and buy just when the market has risen. That’s not a plan. It’s a problem.
“Do something fun,” Professor Thaler said. Get away from the news.
