In just over two weeks, the war in Ukraine has disrupted the status of 1.3 million people – approximately the number of people who live in Philadelphia or Phoenix – citizens turned refugees. It is hard to say when the conflict will end or the toll it ultimately takes on Ukraine and neighboring countries.
We often talk about “behavioral finance” and the war in Ukraine provides a perfect example of investors focusing on shorter-term implications. Fears are high, rightfully so; slower economic growth and rising inflation as commodity prices soar, supply chains falter and some goods become more scarce. Comparatively speaking the same conditions were already present before Russia attacked Ukraine, yet markets didn’t sell-off and investors remained sanguine.
The Standard & Poor’s 500 Index, perhaps the most watched benchmark, and Dow Jones Industrial Average are both in correction territory, meaning they are down more than 10 percent from previous highs. The Nasdaq Composite, mostly technology based, is down more than 20 percent from its prior peak, putting it in bear market territory.
From our point of view, the indiscriminate sell-off, particularly of European equities, happened within extremely defensive sectors that were not affected by the crisis. Why is that, and does it make sense? We are not saying to ignore these things, however, we are saying emotional selling seems to be in control across all markets as the broil in Ukraine grows more violent. Just a few months ago, however, markets were making all time highs as our Federal Reserve remained accommodative, gas prices rose, and we continued our endurance of a long in the tooth “pandemic” that destroyed supply chain and employment. Yet, markets shrugged it off. Take a step back and you can clearly see how “behavioral finance” is in full control. As things deteriorate, American’s are also beginning to reassess whether White House leadership is prioritizing correctly.
Last week, though, investors appeared to take a deep breath and begin to reassess.
Major indices in the United States and Europe fell early in the week before reversing course. By the end of the week, stock indices in London, Frankfort, Paris and Milan had regained lost ground. However, U.S. indices finished the week lower after inflation numbers for February were released and talks between Ukraine and Russia failed to produce results.
Inflation in the U.S. rose 0.5 percent in February, excluding energy and food. That was a slower increase than the U.S. saw in December or January. However, with food and energy, which have risen sharply due to the war, inflation was up 0.8 percent and that was higher than December and January numbers. Overall, excluding energy and food, consumer prices were up more than 7 percent over the last 12 months. Some experts say the number is closer to 15 percent when energy and food are included. And, the Federal Reserve is expected to raise interest rates this week as it tightens monetary policy in an attempt to lower inflation. However, we don’t see this as a plausible solution given the global crisis unfolding in Europe. It will take more than simply raising rates.
During the last few years, the world has experienced enormous change. The COVID-19 pandemic led to rapid growth of e-commerce, a new work order (emphasizing work-from-home), innovation in cell and gene therapies (so-called vaccines), and a rethinking of global supply chains. Some of these changes created opportunities for investors. Now, the war in Europe is adding a layer of new changes that have implications for defense, cybersecurity, energy and very likely, other sectors of the market.
What does all this mean and what can we learn? It can be difficult to stay calm during periods of upheaval, but change is often accompanied by opportunity. The chart below provides 10 years of market performance across the most popular metrics. You can clearly see that volatility is temporary and over time, stocks have easily outperformed other asset classes. However, they all did relatively well across certain periods. This reminds us that investing is long-term and that diversification is a key to improving performance.
|Data as of 3/11/22||1-Week||Y-T-D||1-Year||3-Year||5-Year||10-Year|
|Standard & Poor’s 500 Index||-2.9%||-11.8%||6.7%||14.7%||12.1%||11.9%|
|Dow Jones Global ex-U.S. Index||-1.3||-11.6||-10.4||3.8||3.5||2.8|
|10-year Treasury Note (yield only)||2.0||N/A||1.5||2.6||2.6||2.0|
|Gold (per ounce)||1.7||8.7||14.8||15.2||10.4||1.5|
|Bloomberg Commodity Index||-0.5||27.5||46.5||16.3||8.4||-1.3|
In closing, our thoughts and prayers are with the citizens of Ukraine and the many lives effected by what appears to be an unnecessary catastrophe. As we navigate the ongoing challenges of a global economy, our investment strategy remains focused on the long-term while adjusting allocations to improve performance and reduce risk, also known as tactical planning. For now, we remain mostly invested with a few notable changes; reduction in foreign exposure, sector weight adjustments due to continuing inflation and a rising interest rate environment. The economy is contracting and monetary policy tightening, these are all signs of a peaking business cycle. Our next clue is inventories rising, something that is not likely in the foreseeable future.
One Final Thought:
“Be fearful when others are greedy and greedy when others are fearful.”
—Warren Buffett, The Oracle of Omaha
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*S&P 500, Dow Jones Global ex-US, Gold, Bloomberg Commodity Index returns exclude reinvested dividends (gold does not pay a dividend) and the three-, five-, and 10-year returns are annualized; and the 10-year Treasury Note is simply the yield at the close of the day on each of the historical time periods. Sources: Yahoo! Finance; MarketWatch; djindexes.com; U.S. Treasury; London Bullion Market Association. Past performance is no guarantee of future results. Indices are unmanaged and cannot be invested into directly. N/A means not applicable.