Investing
What impact might the Russian invasion have on markets?
We’re assessing sanctions, energy prices and the price action to determine what the conflict might mean for investors.
Our Top Market Takeaways for February 25, 2022.
Markets in a minute
This week, Russian forces invaded Ukraine: the largest military campaign in Europe since World War II. Western officials have been warning of a violent conflict for weeks, but it is still shocking to see such a humanitarian tragedy unfold in real time. The geopolitical ramifications of the invasion are important, and will likely not be fully understood for years, if not decades. Our thoughts are with all of those who are impacted, especially our colleagues, clients and their families.
As investors, our job is to assess what impact the conflict might have on the global economy and financial markets, and then determine if we need to change the advice we are giving about portfolios. To do that, we are watching three areas: the extent of the sanctions placed against Russian entities, the impact on global energy prices, and the follow-through to price action.
1. President Biden along with a number of European countries promised tough sanctions against Russia if it invaded Ukraine, but the market seems to think they are less onerous than expected. Yesterday afternoon, President Biden announced measures that would severely limit Russian banks’ ability to transact in dollars, euros and yen, sanctions on Russian elites and their families, and export controls that are meant to block Russia from receiving semiconductors and other technology. While the measures do alienate the Russian economy, they stopped short of blocking Russian energy exports or cutting them out of the SWIFT communication system that enables cross-border banking transactions. While Biden was announcing the sanctions, the Russian ruble strengthened by over 3% against the dollar, crude oil fell by about 4.5%, and U.S. equities surged by over 1.5%. It seems like the sanctions are designed to limit the amount of economic harm to Europe and the United States, which markets seem to like.
2. The clearest economic and market risk of this conflict is that it catalyzes an energy price shock and a period of stagflation. A scenario like this would resemble the aftermath of the Yom Kippur War in 1973, when the Organization of Arab Petroleum Exporting Countries cut off oil exports to the United States. In that event, the S&P 500 fell by ~40% and didn’t fully recover until 1980. Given that Russia produces ~12% of the world’s oil and ~17% of natural gas, that risk may seem high. In the end, that risk is real, and it is a much greater possibility for Europe than the United States. As our Chairman of Market and Investment Strategy Michael Cembalest noted, 40% of Europe’s natural gas and 27% of its oil come from Russia, and 30% of that energy is transported through Ukrainian territory. The United States, on the other hand, imports just 1%–3% of its oil and gas from Russia.
There are some important caveats. First, it seems like energy was very intentionally left out of the sanctions package by both European and U.S. policymakers because of this very risk. Indeed, Russian gas flowing through Ukraine has (according to Ukraine’s network operator) recovered almost to “normal” pre-conflict levels, and European natural gas prices are still high, but have fallen 25% from yesterday’s peak.
For the United States, the economy is much less reliant on energy than it was in the 1970s. Then, it took about 100 barrels of oil to generate every unit of GDP. Today, it takes less than 40 barrels. Finally, it would take quite an energy price shock to pinch U.S. consumers. Right now, the average production and non-supervisory worker in America makes $26.92 per hour. This means they can buy 7.9 gallons of gas at current prices for every hour they work, just a touch below the average of the last 30 or so years. In 2013, the average worker could only buy around 5 gallons of gas for every hour worked. To get back to that ratio, gas would have to move up to ~$5.38 per gallon, or ~50% higher than current levels.
3. The uncertainty around Russia and Ukraine has been building for weeks. Risk markets suffered as they wondered if Putin would order a full-scale invasion. From February 11, when President Biden warned that a Russian invasion was imminent, to the lows yesterday morning, the S&P 500 lost 10%, the NASDAQ 100 lost over 11.5%, and the ARKK Innovation ETF (a proxy for speculative, young, unprofitable companies) lost over 24.5%. Yesterday, as investors digested the reality of war and the initial sanctions, the S&P 500 gained almost 4.5% from its lows, the NASDAQ 100 rallied over 7%, and the ARKK ETF finished almost 8.5% higher. Conversely, the global energy sector peaked on February 11, and is now down over 5.5% since. A full-scale invasion of Ukraine is a bad outcome, but the questions that investors had to ask have now been answered more clearly. With that context, it makes a little more sense why U.S. equity markets performed so well yesterday.
So what should investors do? The first thing to do is remember that staying invested in a diversified, goals-aligned portfolio has paid off through countless geopolitical crises, wars, pandemics and recessions, and will likely continue to do so. This is also not the first time Russia has been the catalyst for market turbulence. Going back to the Soviet invasion of Afghanistan, we identified six instances of Russian aggression. In all but the 2008 invasion of Georgia, which occurred during the Global Financial Crisis, stock markets showed healthy gains both 6 and 12 months later.
In the past, we have noted that most geopolitical shocks turn out to be decent buying opportunities, but we would caution that there are many outstanding questions still to be answered. What is Putin’s endgame? Is it just installing a friendly regime in Kyiv? Or is it continued aggression against other countries? Will more onerous energy embargoes eventually come in to play? Does this embolden China to make a play for Taiwan?
When uncertainty is high, it helps to focus on the fundamentals. At current levels, the S&P 500 is trading at a five-year average price-to-earnings ratio, and seems to be incorporating both slower earnings growth and a higher risk premium relative to fixed income than we think is reasonable, given the underlying momentum present in the U.S. economy. Further, U.S. companies have minimal (~.6%) revenue exposure to Russia and Ukraine. While stock markets will likely remain choppy due to the risks posed by the continued conflict and the upcoming rate hike cycle, we think investors can expect attractive returns for high-quality U.S. equities from here.
Your J.P. Morgan team can help you determine the best course of action for your portfolio, given the market volatility.
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