Key takeaways for markets amid the Russian invasion of Ukraine
On the latest edition of Market Week in Review, Client Portfolio Manager Stephen Doran and Director of Institutional Investment Solutions, Greg Coffey, discussed the market reaction to Russia’s invasion of Ukraine. They also assessed the potential implications of the attack on global central-bank policy, and reviewed how markets have historically fared during geopolitical events.
Markets whipsaw after Russia attacks Ukraine
The Russian invasion of Ukraine—a humanitarian tragedy that will undoubtedly impact the lives of millions of people—led to profound moves in markets as the news broke, Doran said, with equities initially selling off across the board. “European markets opened down 4% on Feb. 24, with U.S. markets also declining by 2% in early trading,” he stated, adding that commodity prices shot higher, with international benchmark Brent crude oil topping US$100 a barrel. U.S. government-bond prices also rallied that day, he noted, with the flight-to-safety among investors pushing yields on the benchmark 10-year Treasury note down to 1.86% at one point.
Doran said the swift reaction wasn’t too surprising, given markets’ disdain for uncertainty. “Markets hate uncertainty—and they were confronted with it in spades as news of the invasion spread around the world,” he remarked, noting that the outlook for markets and economies looked very bleak during morning trading on Feb. 24.
However, markets went on to recover sharply from their opening lows, Doran noted, with the benchmark U.S. S&P 500® Index and the tech-heavy Nasdaq Composite Index rallying by 4% and 7%, respectively, to finish the day in positive territory. As of midday Pacific time on Feb. 25, the rebound was still underway, he added.
“Ultimately, despite all the fear and noise, markets—as of this recording—aren’t at a materially different level than one month ago, when worries over the hawkish pivot of global central banks were driving equities lower,” Doran stated.
Potential impacts of the invasion on inflation and monetary policy
Focusing in on central banks, Doran said that the spike in commodity prices following the invasion creates a headache for policymakers trying to tame the highest inflation readings in decades. “It’s important to note that the jump we’re seeing in prices goes beyond oil and gas, with the cost of wheat also soaring, as both Russia and Ukraine are major producers,” he stated. Doran noted that any further price rises will only add fuel to the inflationary pressures confronting countries around the world, while additionally hampering economic growth.
Policymakers on both sides of the Atlantic weighed in on the issue in the hours following the invasion, he said, with U.S. and European officials signaling that the crisis likely won’t derail their intended path for rates. U.S. Federal Reserve (Fed) Governor Christopher Waller even went so far as to suggest that a 50-basis-point rate hike at the central’s bank meeting next month might be justified, Doran noted.
“While an increase in the federal funds rate of this magnitude is not our central scenario—we believe a 25-basis-point rate hike is more likely in March—comments like these do send a strong signal that global central banks are going to be raising borrowing costs,” he stated. Overall, central-bank leaders believe both economies and consumers are in strong enough shape to warrant higher interest rates, Doran remarked.
How have markets reacted previously to geopolitical events?
Shifting to potential investor impacts of the invasion moving forward, Doran said that a look at history reveals that financial markets are relatively efficient at pricing geopolitical events—and tend to recover quickly. The most obvious historical comparison to today’s events—which was also the most significant in terms of market impact—is the Iraqi invasion of Kuwait in 1990, he said.
“The S&P 500 fell 1.1% the day the Iraqi invasion began, as such an outcome had already been discounted by markets. Over the course of the next 10 weeks, the index declined by nearly 17%—and then took just over six months to claw back all of its losses,” Doran noted. This example shows that while the stock market is undoubtedly impacted by geopolitical events, it does tend to move past them relatively quickly, he observed.
Assessing today’s events through the lens of Russell Investments’ cycle, valuation and sentiment framework points to a constructive, rather than defensive, outlook for portfolios, Doran said. This is because the economic cycle is generally supportive of equity returns, while valuations—although not cheap—have improved slightly from the start of the year, he explained. Meanwhile, sentiment—which Doran characterized as the emotional pulse of the market—has become oversold and is moving incredibly close to a level of capitulation. “Historically, when markets have reached this level, it’s been a powerful buying signal,” he concluded.