Crisis in Ukraine

“This commentary provides a summary of our portfolio management team Advisory Alpha’s perspective on the recent geopolitical, economic, and financial market uncertainty due to Russia’s invasion of Ukraine.”

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.

Geopolitical Impact

So far, many strategic cities within Ukraine have fallen to Russian occupation. 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.

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.

Economic Impact

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. The economic cost to many westerners will likely be higher energy prices.

The US capital markets are 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 may 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.

Investment Impact

The uncertainty in Russia and Ukraine has and will likely continue to impact the financial markets, specifically stock prices. Amid 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 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 disklike 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 the economic change happens. Therefore it’s important 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 might be 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 financial plan. Unfortunately, it is often easy to become overly focused on feeling as if you need to make investment changes during 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 should 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.

Source: Advisory Alpha