When 2022 began, not many on Wall Street suspected that Russia would invade Ukraine. There was a long list of primary concerns that might impact stock prices (rising interest rates, stock valuations, new COVID variants, high margin debt levels, and a calendar overdue for a “correction”) but not a war. Yet here we are, two months into the New Year, and the war and its looming implications are, in effect, the only news. Stock prices have responded as one would expect: US stocks, as measured by the S&P 500, fell 3.1% in February and are down 8% year-to-date.
In assessing the stock market, there are no segments or sectors of the market which have generated positive returns (with the exception of energy stocks). Bonds, the traditional safe haven when stocks are misbehaving, are down across the board with the exception of some floating rate issues. Unsurprisingly, Russian stocks are down 40% in local currency and have generated an average annualized return of 0.9% over the last 15 years. We typically own stocks of US corporations and rarely own stocks domiciled outside the US, and not surprisingly, have never owned a Russian stock or bond. In times of crisis, it is common for the correlations of asset classes to trend toward 1. This means that apart from gold or US T-Bills, virtually no financial asset has escaped the downward price pressure this year.
There is some good news. COVID figures are declining rapidly, the US economy has stabilized, the Labor Department reported strong job growth in February with 678K new jobs, and unemployment fell well below historical averages to 3.8%. FactSet reported that 4Q ’21 revenue and earnings growth reported by US corporations was healthy. According to the New York Fed, median three-year-ahead inflation expectations have decreased by 0.5 percentage point to 3.5%. This is an indication consumers do not believe the current high levels of inflation will persist. The geopolitical backdrop may lead the Federal Reserve to temper rate increases and Chairman Powell recently said he supports a 25 basis point rate hike at the Fed’s March meeting as opposed to a more hawkish 50 basis point hike. The war has given social media platforms the courage to impose more stringent guardrails and curb the way they are accessed by propagandists around the world. In response to the war, populations have coalesced around the globe in support of Ukraine, human rights, and democracy.
Future earnings are the primary anchor for stock prices and the many factors effecting US corporate earnings are considerably more difficult to forecast with war in Ukraine and the coordinated punitive sanctions. The war has caused commodity prices to spike, primarily affecting oil, which represents approximately 45% of Russia’s exports and a significant source of cash for the government. This will potentially lead inflation to linger higher for longer and certain sanctions may have unintended consequences we cannot factor in at this point. There is also risk of fallout from a Russian financial crisis which may well impact parts of the banking sector in Europe.
We have endured a number of bear markets over the years, and with that history in mind, there are steps we can take to navigate this challenging moment in time. We want to continue to own stocks of domestic companies with demonstrated transparency (information/earnings), strong liquidity and high qualitative measures (balance sheet, earnings stability, dividend history) as the primary criteria. Cash levels are critical. We want to look ahead to your anticipated spending needs and make sure enough cash, or cash alternatives, is available in your account. Patience is also necessary, as it will take some time for the geopolitical situation to defuse, and then we still may be faced with the list of concerns we had in front of us when the year began.
Please feel free to reach out to us if you want to talk. It is tax time, so please let us know if you need help with your end of year reporting. We look forward to seeing you in person again, as it does appear the worst of the pandemic may be behind us. We are renovating our offices and will gladly host you there in the early summer months.
Until then, take good care.
Bruce Hotaling, CFA
The views and opinions stated herein are those of Bruce Hotaling, are of this date, and are subject to change without notice. Information contained in this report was received from sources believed to be reliable, but accuracy is not guaranteed. Investments are subject to market risk, including the possibility of loss of principal. Past performance does not guarantee future results. The S & P500 is an unmanaged index of 500 widely held stocks. Investors cannot invest directly in an index. The PE ratio (price/earnings) is a common measure of relative stock valuation.