Russia invades Ukraine. What does this mean for investors?

What many feared may happen came true overnight with Russia invading Ukraine from all sides—Crimea, Belarus and Russia.

Events have moved quickly since our update on February 22. It’s unclear whether this is the shock and awe phase of a limited incursion or the beginning of a full-scale invasion that seeks regime change in Kyiv. The invasion represents a humanitarian tragedy with terrible consequences for millions of people. Investment markets are now reacting to the uncertainty created by events. The implications for European and global political stability are a key issue. We are evaluating the portfolio implications of events through our cycle, value and sentiment (CVS) framework. We’re assessing the risks to our global cycle view from a full-scale invasion. We also continue to monitor our composite sentiment index to judge whether investor psychology has reached an unsustainable level of panic that justifies a more risk-on stance.

Markets react

USD/RUB touched 90 overnight before fading back to the mid 80s—a record low. Global stocks tumbled, with the S&P 500 Index falling 2.50% at open, while havens and commodities surged. The flight to safety saw the 10-year U.S. Treasury yield touch 1.86% and gold hit the highest since early 2021. The dollar and yen jumped, while the euro and commodity currencies retreated. European natural gas soared as much as 41%, while West Texas Intermediate (WTI) crude oil topped $100 and aluminum hit a record. Bitcoin slumped.

Impact on fixed income

Both Russia and Ukraine sovereign debt are facing sharp declines, down 30-40 points across the curve overnight. Russian credit is also wider by 20-30 points, depending on the name and credit quality. In the U.S., a seven-year Treasury auction is scheduled for this afternoon and many are expecting the highest seven-year yield since July 2019.  Investment-grade credit is wider by five-to-seven basis points, with high-yield credit down 15-20 basis points, led by lower volume of 10%. Treasury flows are mixed.

Impact on our portfolio positions

At this moment, we are not looking to materially change the positions of our portfolios. As we stated above, our investment decisions are always driven by our cycle, valuation and sentiment indicators, which tend to ignore geopolitical noise. We believe a diversified multi-asset investment portfolio should be designed to deliver returns over the long term. By design, they have exposure to multiple asset classes that will react differently. For example, the fixed income exposure within portfolios, particularly government bonds, typically increase in value during times of stress. This, alongside other defensive asset classes (such as gold, Japanese yen or U.S. dollar) should help offset some of the impact from equity moves. Shorter term volatility, while worrying, is normal when investing. We are currently assessing the current market reaction and could be looking at some opportunities to selectively add to risk assets should our sentiment indicators point into this direction.

Is concern over a larger market pullback warranted?

While the situation in the Ukraine is both unique and developing, financial markets tend to recover quickly from geopolitical events. We continue to point back to the most obvious historical comparison, which was also the most significant in terms of market impact, is the Iraqi invasion of Kuwait in 1990. The S&P 500 Index fell 1.1% on the day, as the probability had been discounted by markets. The benchmark U.S. equity index would go on to decline by 16.9% over the course of 10 weeks, taking just over six months to recover. The key takeaway here: Stock markets can move past geopolitical events relatively quickly.

Historically, the main driver of whether we see a correction (a fall of, say, 10% to 15%) or even a mild bear market (with, say, a 20% decline that turns around relatively quickly) as opposed to a major bear market is whether there is a recession in the United States. In our view, recession risks, at least for the next 12 to 18 months, look relatively low. Strong household and corporate balance sheets leave us positive on the ability of the U.S. and global cycle to deliver significantly above-trend economic growth in 2022. Although the Fed is likely to begin lifting interest rates as soon as March, we believe it will take until at least the second half of next year for monetary policy to transition from being less stimulative to having a contractionary impact on the economy.

The bottom line

We continue to look at both markets and our own portfolios holistically, keeping an eye both on our forward projections and historic cycles for context. Global markets are already complicated, and exogenous events like the situation in Ukraine only complicate them further. Make sure you are working with a strategic partner with both a holistic approach and the right set of capabilities to help you reach your desired investment outcomes.