by Jordan Hucht, CFP®, ChFC®, AIF®
With the situation in Ukraine now escalated into actual military conflict, it’s natural to be concerned about the impact on the financial markets and your portfolio. So, let’s examine what the latest developments mean for your investments and financial planning.
First, some historical context. Generally speaking, when past geopolitical crises have escalated to armed conflict, financial markets have had an initial, sharply negative reaction during the “pre-war” period. But as you look further out a month or two — or especially a year or more — from the onset of conflict, markets have fared well in most cases. So far, we’ve seen the sharply negative reaction in the lead up to and now beginning of armed conflict. Whether the next few weeks follow the historical trend is, of course, a story yet to be told, but I think the historical context is helpful to understand.
Next, let’s remember where we were heading into this. Since the beginning of the year, markets have been under pressure for various reasons, the Russia-Ukraine situation being one of them. At this point, a fair amount of damage has been done, with the S&P 500 index now down about 13% from its all-time high at the turn of the year. That’s certainly a significant move, but also pretty much in line with the longer-term average intra-year decline of the index. As I noted in January, it’s been almost 2 years since we’ve seen a drawdown of this magnitude, so the reality is that investors have been spoiled by the recent lack of volatility up to this point.
Now, let’s remember what was driving the volatility, exclusive of the Russia-Ukraine situation. The primary driver, in my opinion, has been the concern of whether the Fed will be able to bring inflation under control through tighter monetary policy without derailing economic growth in the process. Tighter monetary policy means, among other things, higher interest rates, which tend to negatively affect stock valuations, especially those with especially high valuations. As a result, we’ve seen a valuation adjustment to the broader market. How the Fed’s policy changes will impact corporate earnings and economic growth will dictate future valuations.
Given this backdrop, I think the best way to consider the financial impact of the war in Ukraine is to consider its impact on US economic growth, corporate earnings, and Fed policy decisions. For example, one of the most direct, immediate impacts is likely to be higher energy and certain commodity prices, as Russia is a significant exporter in those categories. In an environment where inflation is already elevated, that’s not welcome news, so we’ll need to watch the impact of those higher costs on corporate profit margins and consumer spending. As things play out over the coming days and weeks, we’ll have a better understanding of other financial impacts as we see how the US and NATO’s responses evolve.
The war in Ukraine is clearly concerning and justifiably so, but I’d argue that inflation and the ability of the Fed to bring it under control without derailing economic growth in the process is still the biggest risk the markets face. The war in Ukraine will be one of many contributors to this outcome.
So what does this mean? It means that I’d expect volatility to continue over the coming weeks as uncertainty keeps markets on edge. But I’d also expect attention to start to shift to the Fed’s next meeting in mid March. Over the next few weeks, some of the uncertainty should resolve as we see the international response to the war in Ukraine and the Fed charts the beginning of its course for rate hikes this year.
As with all periods of volatility, it’s important to stay disciplined and keep a long-term perspective. Sound financial planning includes, if not requires, preparing for times like these.
Securities and advisory services offered through Commonwealth Financial Network®, Member FINRA/SIPC, a Registered Investment Adviser.
Certain sections of this commentary contain forward-looking statements that are based on our reasonable expectations, estimates, projections, and assumptions. Forward-looking statements are not guarantees of future performance and involve certain risks and uncertainties, which are difficult to predict. All indices are unmanaged and are not available for direct investment by the public. Past performance is not indicative of future results.