by William Henderson, Chief Investment Officer
Market volatility prevailed last week as the Russia / Ukraine “crisis” spiraled into a full-scale invasion and war between the two countries. On a continent that has been free of international aggressions of this sort since WWII, Russia acted unilaterally and invaded Ukraine. International reaction was mostly unified with quick condemnation from all countries except China, who remained silent. Markets ended the week on a mixed note, but wild price swings of 500 and 1000 points (on the Dow Jones Industrial Average) were common all week. The Dow Jones Industrial Average fell -0.7%, the S&P 500 Index gained +0.1% and the NASDAQ lost -0.2%. Year-to-date returns remain well in negative territory for all three major indexes. Year-to-date, the Dow Jones Industrial Average is down -6.0%, the S&P 500 Index is down -7.8% and the NASDAQ is down -12.4%. Even bonds were not spared last week in the modest sell-off as the yield on the 10-Year U.S. Treasury rose five basis points week-over-week to end at 1.97%.

The Russian invasion has spiked market volatility, increased uncertainty around the pace of the global recovery from the pandemic and thankfully brought unilateral financial sanctions to Russia. Volatility results simply from the uncertainty surrounding the duration of the Russia / Ukraine war and the impacts it is having on commodity prices; as Russia is a significant producer of several major global commodities such as oil, wheat, and palladium (a critical rare earth used in catalytic converters). See the chart below from FactSet showing the recent spikes in prices of oil and wheat.  

Thankfully, the reaction from the global community to the Russian invasion has been dramatic and financial sanctions such as limiting access to SWIFT banking channels and freezing of $630 billion of foreign reserves have already had an impact. Russia has closed its stock market, and the Russian Central Bank raised short-term rates from 9.5% to 20% to defend the tumbling Ruble. Of course, the reaction by the Russian people was a run on banks and ATMs in a last dash effort to get hard currency before an expected crash. Beyond financial sanctions and hardship on Russians themselves the international community has been swift in condemning Vladmir Putin personally and supporting Ukraine as much as possible. Given Ukraine is not a NATO country but borders several including Poland and Romania actual military support will be precarious and certainly measured baring a full-scale global conflict. 

As mentioned, fear, uncertainty and volatility are never associated with good times in markets – in fact quite the opposite. However, historically, markets look past geopolitical events and move higher over extended periods of time; and that alone should be an investors’ focus. (See the chart below from Haverford Trust & Ibbottson. Associates showing major geopolitical events and the increase in $1 invested in Large Cap Equities).  

While the underlying strength in the U.S. economy and thereby the markets exist, the current global uncertainty will prevail and grab all headlines. Higher commodity prices, specifically oil, have the propensity to impact the recovery and ongoing growth in the economy. Whether sanctions will prevail, and Russia retreats or U.S. policy makers impact markets by releasing strategic petroleum reserves, opening the Keystone XL pipeline or allow fracking again, we shall have to see. Typically, sell-offs in markets are short-lived and offer buying opportunities for longer-term investors. This week Fed Chairman Jay Powell reports to Congress and we may hear comments around the pace of rate hikes and balance sheet reduction in 2022. That story is significantly more important than what we are hearing from our national news media. Lastly, on Friday we will get another reading on U.S. employment conditions as the February jobs data is released. 

by William Henderson, Chief Investment Officer
Gangbuster numbers in retail sales and existing home sales failed to move markets higher as the continued unrest in the Russia / Ukraine put a damper on the markets. President Biden spoke towards the end of the week and said, “he believed an invasion by Russia into Ukraine was imminent.” That is all the fragile markets needed to chalk up another losing week across all three major stock market indexes. The Dow Jones Industrial Average fell -1.9%, the S&P 500 Index lost -1.6% and the NASDAQ lost -1.8%. Weekly returns added to a poor year so far in 2022, and all three major indexes are sitting on negative year-to-date numbers. Year-to-date, the Dow Jones Industrial Average is down -6.0%, the S&P 500 Index is down -8.6% and the NASDAQ, which naturally tilts to growth stocks and is much more sensitive to interest rates moves, is down -13.3%. Fortunately, as we have said over and over, when risk assets sell off, investors flee to the safety of bonds. Treasury rates moved lower across the curve 1-5 basis points: while the 10-Year U.S. Treasury Bond remained unchanged at 1.92%. 

The geopolitical situation remains fragile, but markets have typically tended to look past lesser geopolitical crises, instead focusing on where there may be pockets of economic impact. For example, Russia remains one of the largest oil producers especially in the European region where it also supplies up to 40% of natural gas to the region. We’ve certainly seen an impact on oil as the price of a barrel of West Texas Intermediate (WTI) has increased over the past several months. See the chart below from FactSet of the price of WTI since February of 2021.   

Oil is a critical component of many things well beyond simple heating and gasoline and the impact of higher oil prices are felt everywhere. As recent as 2019, the United States was completely oil independent producing enough energy to supply our own needs. The current administration killed the Keystone XL and banned new fracking on day 1 of taking office.   

Beyond the Russia / Ukraine situation there were pockets of good news, as mentioned above. Sales of existing homes rose +6.7% in January from the prior month to a seasonally adjusted rate of 5.5 million units, according to the National Association of Realtors. The housing market remains extremely competitive even in the face of rising mortgage rates in recent months. Additionally, U.S. retail sales for the month of January came in well ahead of expectations at +3.8% vs estimates of +1.9%, despite continued noise around the omicron variant. Retail sales increased in online sales, furniture and autos. As mentioned last week, the consumer remains well positioned to fuel the great “second reopening” of the economy especially as we move into spring and summer travel season. 

A final piece of economic news released last week was the Fed minutes from the January FOMC meeting. The minutes provided some comfort to the markets as they did not seem overly hawkish (higher rates) and contained no material surprises.  Economists had been predicting a +0.50% rate hike at the March 15-16 meeting; but the minutes revealed a Fed willing to raise rates at a gradual and measured pace. Almost immediately, markets adjusted the probability of a +0.50% rate to less than 33% from 94% (see chart below from FactSet showing the change in rate expectations from February 10 to February 17). 

In our opinion, this is good news for the markets. Inflation is running at a level that warrants higher interest rates but interest rates also fuel the economy so it can be a slippery slope for the Fed – raise rates to combat inflation but don’t kill the economic growth we are seeing. We believe a series of +0.25% rate hikes in a gradual, measured, and transparent manner is the right recipe for the Fed to quell inflation but continue to allow economic expansion. We further expect a gradual flattening of the yield curve (curve showing interest rates over time from short-term Treasuries to long-term bonds) as short rates rise but pressure on longer-term bonds continues due to pension funds, foreign buyers and investors seeking bonds as a risk management tool in their portfolios. 

This week we get a few more economic indicators including Revised 4th Quarter GDP (prior +6.9%) and U.S. Initial Claims for Unemployment. It is a holiday-shortened week and headlines will be dominated by the situation with Russia / Ukraine, and less so by the sound foundation underlying the growing U.S. economy.