Our hearts and prayers go out to those suffering in Ukraine. A lot transpired in the last two weeks on the geopolitical and economic fronts. Despite the unsettling headlines, we still see good news for the market.
Where are We Now? Trailing Returns Still Look Good
As of market close on March 9, 2022, the trailing return for various stock indices are still impressive:
CNBC reminds us that pullbacks like we’ve seen year-to-date are quite common. Also, “When dividends are factored in, the S&P has risen 72% of the time year-over-year since 1926.”
According to Franklin Templeton, "Going back to World War II, the median market sell-off has been 5.7% after a geopolitical shock." And, "On average, it has taken three weeks for the market to reach a bottom and another three weeks for it to recover those losses" after a geopolitical event. It's also interesting to note stock market returns during major wars since World War II:
No doubt, this year’s pullback is uncomfortable, especially for investors who got used to the standout returns of the past several years—the S&P 500, on a total return basis, rose 31.5% in 2019, 18.4% in 2020, and 28.7% in 2021. The interesting part is that most of this year's pullback across markets took place before February 18th (which is the baseline for where we started to hear rumblings about an ever-increasing Ukraine/Russia conflict). From February 21st through market close March 9th, broad equity markets were down less than 2.5% while fixed income markets are in negative territory (with global bonds understandably selling off more than US bonds). Not bad, all things considered!
The price of oil has skyrocketed globally with its price exceeding $100/barrel. Will it go to $150 or $200? We do not know. The more important question is, how long will the price stay in that realm? If we get to the summer and there are still prices in this range, you could definitely see the “R”(ecession) word rear its ugly head. However, sustained oil prices do not automatically bring on recessions—brent crude was consistently above $100/barrel from spring 2011 to summer 2014, and the U.S. still saw economic expansion and rising equity indices.
As of this writing, the United Arab Emirates and Iraq signaled OPEC may be more open to raising production. We shall see, but markets responded with the price of oil dropping nearly 10% in a day. And the price continued to drop this morning. Additionally, this week President Biden announce that the U.S. will no longer import oil from Russia. Below is a chart from GZero showing the percentage of crude oil that is imported by the U.S.
Where Do We Go From Here? Stay the Course
Our best advice is to stay the course. At the moment, we do not have plans to change our allocations. If you find an opportunity you would like to take advantage of, we advise you to proceed with caution! We don’t foresee this conflict wrapping up within the next several days and expect more volatility in the short term. In fact, we think this could drag on for months or even years (remember the USSR’s invasion of Afghanistan?). That said, we do believe that markets will recover, and that the Ukraine/Russia conflict will slow—but not completely derail—global economic growth and corporate profits. We are thus comfortable with the amount of risk we currently have in our portfolios.
What Would Cause Us to Reconsider? The Ever-Elusive Next “Black Swan”
With the current geopolitical crises, we analyzed what type of events would trigger a dramatic change in our investment outlook and portfolio positions. Here are a few examples of such events (all of which we believe to be low probability):
Escalation Events (Black Swans)
Material escalation from Putin on the war front—using nuclear weapons, EMPs, chemical or biological weapons, or invading a NATO or EU country
Oil prices remain above $100/barrel for an extended period of time—HOWEVER, as mentioned above, brent crude was over $100/barrel from spring 2011 to summer 2014 and we still had positive (albeit low) economic growth
Stagflation (slowing growth or economic contraction with rising inflation)—not our base case, but the Fed might fail to get inflation under control or tighten the U.S. economy into a recession
Emergence of a COVID variant that is more deadly and infectious than prior variants—this would be quite the black swan considering the typical path of a virus is to mutate towards higher virality and lower mortality, as we saw with the progression from delta to omicron
Any invasion of China into Taiwan, although in our belief unlikely, would have dire economic consequences for many
Thanks for your continued trust in us. Let us know what questions you may have.
Past performance is not necessarily indicative of future performance.