News & Insights
Crisis in Ukraine
March 4th, 2022
By Michael Nordmann |
Financial & Retirement Planning |
High Net Worth |
Russia’s invasion of Ukraine sits at the forefront of international affairs and has sparked geopolitical, economic, and financial market uncertainty. We are in the early stages of the possible implications of this event so the world is attempting to process the various outcomes and scenarios.
So far, many strategic cities within Ukraine have fallen to Russian occupation. The capture of cities in the East seemed like an easy task as much of the Eastern Ukrainian territories see themselves as ethnically Russian. Despite western support for Ukraine and the incredible resistance that Ukrainians have mustered to fight off the Russians, the invasion continues to intensify around the capital city of Kyiv. Unfortunately, Russia’s incursion to take Kyiv may very well be imminent and happen in days. It was always in the playbook of Russia to exercise some sort of control in Ukraine. Furthermore, Russia does not want countries adjacent to its borders joining the North Atlantic Treaty Organization, NATO. NATO is an alliance set up to help protect Europe after the aftermath of World War II. Today, only two NATO partners share a border with Russia. Ukraine’s recent interest in NATO and the European Union has probably motivated Russia to move in now. Additionally, America’s timing to withdraw from Afghanistan may have changed the balance of world power and given Russia the signal that the time to go had arrived.
In 2014, Russia’s president, Vladimir Putin, lost control of Kyiv as a revolutionary guard and the Ukrainian Parliament ousted their then-standing president, Viktor Yanukovych. Yanukovych’s power fell when he sided with a trade union between Ukraine and Russia and rejected the European Union’s deal. It was evident to Ukrainians that Yanukovych was under Putin’s influence at that moment, and an insurrection took place in Kyiv. As a result of losing Yanukovych and Kyiv, Putin moved his forces in and annexed Crimea in Ukraine.
From a geopolitical perspective, this event has profound implications for the future of western democracies and alliances such as NATO. Moreover, as the balance of world power shifts, any weakness shown in the west sends the wrong message to other would-be aggressors.
Russia’s invasion has and will continue to disrupt economic activity and capital markets. Money has already moved as a result of the attack on Ukraine. For example, the west has imposed significant economic sanctions on Russia, and more may still be on the way. Additionally, Germany froze its plan to open a natural gas pipeline to send Russia’s most abundant resource straight into their homeland. Finally, wealth tied up in Russia’s capital markets has lost billions as of late as a result of the sanctions. Global economic change is happening in lockstep with shifts in military might.
The economic cost to many westerners will be higher energy prices. That’s not meant to discount the actual cost of war that only Ukrainian will bear. The people of Ukraine unfairly shoulder all of the inhumane costs associated with an unprovoked war. Still, westerners will likely find themselves paying more for gas and oil in the near future. Russian exports of oil and gas will decline as investment and consumption boycott Russian producers. The result will cause short-term supplies to decline in the marketplace. As a result, crude oil prices have significantly changed in response to short-term supply disruptions, with the price moving above $100 per barrel!
Russia and Ukraine are rich in natural resources. Russia was the world’s third-largest producer of petroleum and other liquids and the second-largest natural gas producer in 2020. Europe is the largest buyer of Russia’s natural gas, and European imports of oil and gas are a primary source of Russian wealth. Ukraine’s primary industries and exports include mined metals and hydrocarbon fuels. Most of Ukraine’s exports land in Russia and other surrounding areas. Specifically, Russia’s oil and gas exports are meaningful to global supplies and have done well in the past to counterbalance any production cuts implemented by OPEC, a cartel of oil-producing countries.
Fortunately, Russia is not a considerable buyer of US exports. In 2019, Russia was the US’s twenty-sixth largest trading partner. The US sent about $11 billion in exports, primarily machinery and aircraft, to Russia in 2019. However, total exports to Russia pale compared to $2.5 trillion of total export trade sent out of the US’s borders in 2019. Therefore, the dependency of sales made in America to Russia barely shows up as a rounding error in the export account.
Nevertheless, US capital markets are still susceptible to the conflict in Ukraine due to the economic sanctions, oil supply frictions, and the escalation of tensions during the war. The anticipated short-term disruption to energy production and investment will shift expenditures in the economy. Specifically, America may have to spend more of its income to consume the same amount of energy. Moreover, higher energy costs would likely take discretionary expenditures out of other economic industries. As a result, US capital markets have indeed moved reflexively on the basis that spending patterns may change here in the US.
The uncertainty in Russia and Ukraine has and will likely continue to impact the financial markets, specifically stock prices. In the midst of the opinions and media associated with this event, investors should consider investment philosophies and strategies that have stood the test of time. History reveals certain investor behaviors that unfortunately have led to negative financial outcomes. So, it is important to refrain from making radical shifts in portfolio strategy or allocations without fully analyzing the possible long-term implications.
1. Uncertainty is often exponential, not additive.
Russia’s war in Ukraine, unfortunately, comes at a precarious time for the financial markets. The markets are already in the process of interpreting the lingering impacts of COVID and, more recently, the possible implications of the Federal Reserve’s monetary policy shift. More specifically on the monetary policy front, the Fed has become transparent on its goal to begin restricting the money supply in an effort to combat rising inflation. In recent weeks and months, the Fed’s forward guidance caused stock market volatility and higher market yields. The challenge is that markets hate uncertainty. But the uncertainty of a single event is often unfortunately compounded by uncertainty brought by new events. In these situations, the markets can become increasingly sensitive and volatile in the short run. Over the long-term, this uncertainty begins to wear off and markets then readjust based on the reality of the situations. Of course, there is no telling how long the uncertainty with COVID, the Federal Reserve policy changes, and the Russia-Ukraine conflict will persist. However, it is important to refrain from making irrational investment decisions based on short-term, highly-elevated uncertainty.
2. Markets attempt to forecast what is coming next.
The financial markets are a leading economic indicator, which means that asset prices tend to forecast what is coming next in the economy. Recently, we experienced this concept play out yet again in regards to the Fed’s anticipated change of policy direction. The Fed has not yet increased interest rates, yet the stock and bond markets have adjusted rather aggressively based on that information. Similarly, the financial markets responded to the Russia-Ukraine conflict ahead of any sanctions going into effect. Markets will continually process new information, which causes asset prices to respond well before economic change happens. Therefore the point is to consider what information has already been factored into asset prices before making decisions to buy or sell.
3. Missing single best days in the market is detrimental in the long term.
Common investor behavior is to feel the pain of a financial loss at disproportionately higher levels than the pleasure that comes from a financial gain. Psychology has a name for this feeling, often referred to as prospecting, loss aversion, or mental accounting. This often overwhelming emotion to sell short-term losses only to avoid feeling bad if losses worsen can lead to long-term negative outcomes for investors. Interestingly, some of the single best-performing days in the stock market follow shortly after the single worst-performing days. Further, if you improperly time the stock market and inadvertently miss out on some of the best-performing days, your long-term value is significantly affected. Despite the behavioral feelings associated with significant market events, such as the Russia-Ukraine conflict, it is important to make measured investment decisions based on your long-term objectives rather than short-term emotions.
4. Intra-year drops are normal but markets are up more often than down.
Over the last 20 years, the S&P 500 has experienced few calendar year returns that ended in a loss. Analyzing this historical data often masks the fact that nearly 75% of the S&P 500’s last 20 years have experienced intra-year declines of greater than 9% loss. Further, since 1926, nearly 75% of the S&P 500’s calendar years have been positive. The point is that short-term volatility is normal for stocks, and events that may feel catastrophically unprecedented are quite common (COVID, Fed Policy changes, the downgrade of US Treasury debt, wars in the Middle East, Russia-Ukraine conflict, etc.). Yet, long-term positive returns are also the typical outcome for the US stock market. Of course, there is no guarantee of future positive returns, but history shows that risk is essential for stocks, which ultimately drives the long-term returns that investors have come to expect.
5. Investment decisions should be the result of a well-constructed, comprehensive plan.
Unfortunately, it is often easy to become overly focused on feeling as if you need to make investment changes in the midst of highly-publicized events. Proper consideration should be given to the role your broad financial plan plays in your investment decisions. If your financial picture has not changed, it is unlikely that you need to make radical investment management changes at this time. If you abandon your financial plans by making contrary investment decisions, you may experience challenges to your broader financial planning goals, such as negative tax implications, increased longevity risk (outliving your retirement savings), and adverse estate planning issues.
Investment advisory services offered through Maner Wealth, a State of Michigan Registered Investment Advisor. Subadvisory services offered through Advisory Alpha LLC, a SEC registered investment advisor.