Over the last several weeks, geopolitical concerns & Russia’s invasion of Ukraine have only added to the downside pressure in the financial markets that were already facing significant headwinds over surging inflation & corresponding interest rate hikes. We are now just over two weeks into Russia’s invasion of Ukraine & the impacts are being felt across the country & across the world. It is important for us to note that the humanitarian toll that any war takes on innocent lives is unacceptable & Russia’s actions are already being punished through severe, multi-nationally supported sanctions aimed at destabilizing the Russian economy. Since the start of the war, the Russian Ruble has lost more than half of its value – it now takes 120 Russian Rubles to buy $1, whereas before Russia’s invasion, it only took 75 Rubles to buy $1 & Russia’s stock exchange, which the Bank of Russia halted trading on February 28th, has been crushed as these sanctions start to be felt. It is also important to note that sanctions on Russia’s assets & economy is really the only tool that the U.S. has at its disposal as Ukraine is not a NATO member & as a result, NATO members, including the U.S. are not obligated under Article 5 to come to Ukraine’s defense militarily. However, should Russia continue its threatening behavior & continue its push West, that would bring a very dangerous situation into play if they were to attack a NATO member, something that no one in the world wants to see happen.
Market Update – Geopolitical Concerns Rock the Markets
The most recent sanctions to come out of the U.S. included a ban on imports of Russian oil & natural gas, which sent crude oil futures surging & equity markets plunging. However, as the graphic below shows, historically, equity markets tend to rebound after the dust settles following the initial selloff on headlines of war breaking out in some corner of the world.
That being said, the combination of surging inflation, rising interest rates, ongoing supplychain issues & now throwing a war into the mix is a scenario unlike anything we have seen before. Yes, we have seen times of rising inflation & rising interest rates. We have also had supplychain constraints, albeit not nearly to the extent that we have seen over the last two years. And, of course, there have been wars & conflicts that the markets have had to weather. However, there is not a time in recent memory that all four of these factors have come into play all at once & to the magnitude that we are currently seeing. As a result, we would expect the volatility in equity markets to continue for quite some time & most likely until we see some sort of resolution between Russia & Ukraine.
What is the Domestic Impact & What are U.S. Companies Doing?
The most obvious domestic impact has been the selloff that we have seen in the equity markets, with the S&P 500 selling off by more than 6% since the beginning of February when mumblings of a potential Russian invasion of Ukraine began to make headlines. Additionally, we have seen surging gas prices at the pumps with the national average hitting $4.104/gallon, eclipsing the previous record of $4.103/gallon that we saw in 2008 & some places such as Los Angeles seeing gas over $6/gallon. Furthermore, some economists warn that we are only just beginning to see a surge in oil prices & warning that oil prices could go higher & remain there for quite some time. Looking at the graphic below, the price of Brent Crude oil for the contracts expiring in May 2022 has more than tripled from its pandemic lows of $40 (yes, the price of oil did go negative but that was for contracts that were closest to expiring) with most of these gains coming since the start of the year. Just this week, President Biden has made calls to Venezuela & Saudi Arabia to inquire about the possibility of those countries increasing their oil output.
Meanwhile, U.S. companies such as Apple, Coca-Cola, Pepsi, McDonald’s & Starbucks, just to name a few, have begun to suspend operations & temporarily shutter locations in Russia as they express their corporate disapproval for Russia’s invasion of Ukraine. Most of these companies derive a very small portion of their revenue from Russia/Ukraine so the earnings impact from suspending these operations should not be huge but it is always disconcerting when a company suspends operations over such a large region. That being said, with 1st quarter earnings season just a month away, companies will undoubtedly have questions to answer with regards to how the suspension of their operations in Russia & Ukraine has impacted 1st quarter earnings & how they expect a prolonged conflict to impact future earnings.
With so much uncertainty surrounding the ongoing Russia/Ukraine crisis, potential further sanctioning of Russian assets & how this will influence domestic policy, we will continue to monitor the situation. We have recently been decreasing our exposure in names that do generate a portion of their revenue in Russia/Ukraine & now screen for that when researching new names. Additionally, there have been some whispers that the Fed may be less aggressive with its interest rate policy as a result of the geopolitical turmoil, however, Fed Chairman, Jay Powell, did say at a recent testimony in front of Congress that he is still in favor of a 25bps rate hike at next week’s FOMC meeting. We also maintain our view that the Fed will raise interest rates 3-4 times this year. While we believe volatility will remain for the foreseeable future, a 20x price-to-earnings multiple on earnings estimates of $223.62 (CFRA’s 2022 earnings forecast) does give us a 4,472 level on the S&P 500. So, we believe that there still is some room to the upside but with the caveat that it will almost certainly be a bumpy road.