Equity markets are fluctuating as uncertainty grows around a potential Russian invasion of Ukraine.
Market reactions to war and crisis events can be tricky and hard to quantify. Each one is different, happening under different market and economic conditions with different factors at play. If we look at past market reactions, you can see that returns on the S&P 500 differed by event but were largely unaffected. We do point out that the 9/11 attack also coincided with the dot-com bubble, so attributing the 1-year return solely to that event might be misleading.
Source: Cetera Investment Management, FactSet, Standard & Poor's. Returns shown are total returns, which include dividends.
Since each event does have different factors, let’s dive deeper into what could potentially happen if a Russia/Ukraine conflict did escalate.
Russia is a large energy-producing country, producing a lot of oil and natural gas for Europe. Potential sanctions on Russia could reduce this energy supply and cause oil and gas prices to rise, thus increasing inflation further. Europe is in a tough bind on this as they recently decommissioned nuclear energy plants, banned fracking and is coming off an extremely harsh winter a couple years ago, which diminished fuel inventories.
The wild card in this is central banks. In the U.S., the Federal Reserve is focused on raising rates and markets anticipate a 1.50% to 1.75% increase in rates (the equivalent of six to seven 0.25% hikes) this year. We currently believe that the market is overestimating the Fed’s hawkishness, but a potential conflict could cause inflation to rise further, as we discussed. This would put the Fed in a tougher position. A conflict could also hurt growth which may cause the Fed to become more dovish as future inflation prospects may fall.
Meanwhile, China and Taiwan are both watching this conflict closely as China continues to declare its intention to reunify with Taiwan. U.S. debt to GDP is already at World War II levels after all the fiscal stimulus that was passed for COVID relief. One could argue the U.S. along with its NATO allies can’t afford any type of military conflict right now. This could potentially limit the extent of any NATO interventions.
Trying to anticipate what may happen is extremely difficult. To further extrapolate the market impact is even harder. We reiterate that in 2022, our primary investment themes are slowing economic growth, a more hawkish Fed and an increase in market volatility. With market risks rising, we continue to anticipate more volatility in the near term. Any disruption to current expectations could be a headwind for stocks, and with high stock market valuations, this could amplify any volatility. Still lingering stimulus, a financially healthy consumer and the eventual abatement of supply chain issues suggest limited market downside.
We maintain that diversification is the key in this market. We can help you stay focused on your long-term risk and return goals and help you with your personalized investment objectives.
This report is created by Cetera Investment Management LLC.
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