Frying Pan into the Fire: Geopolitical risks taunt already unsettled markets

Aoifinn Devitt | Chief Investment Officer
Chris Kamykowski, CFA, CFP® | Head of Investment Strategy and Research 

In mid-January, a headline in the Wall Street Journal screamed that “Omicron (had) killed certitude.” The opinion-writer was right; in the first few weeks of the year, certitude has been replaced by sharp market sell-offs, worries around inflation, shifting interest rate expectations, and the specter of war between Russia and the Ukraine.

Over recent months, inflation speculation and indicators finally “crossed over” beyond what policy makers could tolerate and – with a shift in rhetoric – a new “assertive” stance was telegraphed. Inflation levels are at a 40-year high (7.5%) in the US, with a similar pattern in other developed markets, and wage pressures mounting.

This has quickly driven speculation as to the pace and magnitude of future rate rises, with most estimates pricing in 4-5 rate rises in 2022 and some expecting a double (50 bps) rate rise in March as occurred in the United Kingdom, where the Bank of England initiated back-to-back rate rises in January and February – the first time that it has done so since 2004.

Despite the US 10-year nudging above 2% just recently, the yield curve remains remarkably flat, suggesting that rate rises might see a ceiling relatively soon and that the current wave of inflation will not be sustained or drive relentless upward pressure on interest rates. Other factors that suggest the current wave of inflation may prove less sticky are the ongoing strong dollar, the lack of a rush into traditional inflation hedges like gold, and the suggestion that supply chain issues will ease as COVID restrictions are lifted.

For now, supply chain issues and labour shortages are persisting, with energy prices and anomalies such as used car prices driving much of the increase while house prices are also continuing to soar. We recommend building inflation resilience in portfolios by maintaining exposure to inflation-linked assets such as real estate, infrastructure and traditional equities, which tend to provide protection in inflationary environments.

Markets have been decidedly less enthusiastic about the high-growth tech stocks that drove markets since March 2020. Since the beginning of the year, both the S&P 500 and the Nasdaq are in negative territory. Markets have seen a rotation in favor of value stocks and “old economy” stocks such as banks who would benefit from a higher rate environment.

Geo-political concerns have also taken their toll on markets after months of markets shrugging off geopolitical developments. Most prominent at the moment are the ongoing actions by Russia in Ukraine, which have stoked fears of war for the markets and Western government leaders this year. As of February 21, 2022, Russia has formally recognized two separatist, rebel-held regions in the Ukraine as independent and ordered Russian troops into these regions to serve as “peacekeepers.” Western leaders have condemned these actions, characterizing the actions as an “invasion” and announcing efforts to implement sanctions on Russia. Germany was the first to respond with actions as it halted the approval of the Nord Stream 2 pipeline, the $10 billion pipeline carrying natural gas from Russia to Germany. This comes even as energy supplies are already fraught with supply chain shortages and high pricing, as many consumers have experienced at the gas pump or in their heating bill. The US followed this up with additional sanctions such as limiting Russia’s access to Western capital markets and measures targeting key Russian individuals and banks.

Overall, as of this writing, markets are taking the news in stride with modest losses in US and European markets; to be sure, the S&P 500 entered the correction zone as it is down 10% from its early January high. Commodities have been well behaved, although slightly higher,  and US Treasury yields are up modestly. The same cannot be said for Russian equities; The MSCI Russia index is down  -16% in February and -22% year-to-date (Russia represents 3% of the MSCI Emerging Markets index). This is similar to market reaction to the 2014 Russian take-over of Crimea from Ukraine. While there were other factors at play that year (as there are today), markets generally came out of the conflict in decent shape with the exception of Russia, which had the double hit of economic sanctions and oil crashing in late 2014.

As with any confluence of events outside of one’s control, investors may be seeking to “do something” because of the uncertainty arising from a variety of market narratives. However, our recommendation remains the same: stick with the long-term investment plan aligned with one’s goals and risk tolerance while maintaining a diversified portfolio to help weather volatility that the market will undoubtedly experience throughout each year. This strategic approach is aimed at preventing short-term allocation shifts over near-term events, which can create an unnecessary drag on long-term investment results. Broad-based exposures to a variety of asset classes, styles, sub-sectors, and regions will have both winners and losers over time, but will help keep one on the path to success even as markets and events test one’s patience.

©2022, Moneta Group Investment Advisors, LLC. Trademarks and copyrights of materials referenced herein are the property of their respective owners. These materials have been prepared for informational purposes only based on materials deemed reliable, but the accuracy of which has not been verified. Past performance is not indicative of future returns. You cannot invest directly in an index. These materials do not constitute an offer or recommendation to buy or sell securities, and do not take into consideration your circumstances, financial or otherwise. You should consult with an appropriately credentialed investment professional before making any investment decision.

Additional articles