From Russia With…Tanks?

February 10, 2022

“Russia is a riddle, wrapped in a mystery, inside an enigma.” – Winston Churchill

After a phenomenal 2021, stocks are off to a bumpy start in the new year. Much of the volatility can be attributed to shifting expectations around Federal Reserve policy as the Fed is expected to be more aggressive than previously anticipated in raising interest rates and tightening monetary policy. However, investors are also paying attention to rising tensions between Russia and Ukraine and whether those tensions will result in an all-out Russian invasion of its neighbor. Although the massing of 100,000 Russian troops on Ukraine’s border immediately triggered the threat of harsh economic sanctions on Russia from the U.S. and its NATO allies, along with the possibility of military intervention in the region, Vladimir Putin has yet to back down. Even geopolitical experts intimately familiar with Putin cannot seem to predict what Russia will ultimately do. Churchill’s quote of more than 80 years ago remains quite apropos.

As the world grapples with the greatest threat to international security and stability in Europe since the advent of World War II, what might we expect if Russia does invade Ukraine (or even if it doesn’t)?

  • Oil and gas prices: In the short term, a Russia-Ukraine war would spark further increases in oil and natural gas prices, especially in Europe. Russia currently supplies 30% and 35% of Europe’s oil and natural gas, respectively. Presumably, those supplies would be cut off in the event of conflict, even if the impact of doing so would also be devastating to the already fragile Russian economy. And, if economic sanctions to prevent a conflict include boycotting purchases of Russian oil and gas, prices would also rise in that event. While an oil and gas shortage may not affect the U.S. given its energy independence, U.S. consumers would still likely pay more at the pump. Higher fuel prices will cause inflation, already at its highest level in four decades, to increase further – at least in the short term.
  • Food and fertilizer: Russia is the world’s biggest wheat grower, and Ukraine is in the top five. A war between the two countries would undoubtedly lead to shortages and higher wheat prices along with other farm products such as barley, corn, and sunflower. Fertilizer supplies might also be affected as Russia is a large provider of ammonia, potash, urea, and phosphates.
  • Metals and manufacturing: Russia is a huge provider of nickel, palladium, aluminum, and platinum. A shortage in any of these metals would impact the supply and prices of kitchenware, mobile phones, medical equipment, and vehicles, among other items.
  • Financial markets: Thus far, markets are pricing in the likelihood of Russia backing down. However, this could change swiftly if there are heavy economic sanctions or an outright war. As we have seen with past bouts of economic or geopolitical calamity, investors often seek the safety of U.S. Treasury bonds, pushing bond prices up and interest rates down. This, combined with a spike in inflation caused by sanctions or shortages as mentioned above, will complicate matters for the Fed as it prepares to raise interest rates in March for the first time since the pandemic. The flight to safety could also favor the U.S. dollar, causing it to strengthen, which will create a headwind for non-U.S. investments as a rising dollar negatively impacts their returns.

While this sounds dire, it should not be seen as a call to action. If we’ve learned anything from past geopolitical crises, it’s to not sell into the panic. The best thing to do is to remain disciplined, especially in the face of increased market volatility. Markets do not like uncertainty, whether it be about forthcoming Fed policy or geopolitical unrest. And markets often react, many times abruptly, in the short-term, before cooler heads prevail. Selling into that panic inevitably leaves one flat-footed and paralyzed with fear just as things turn positive.

Interestingly enough, when looking at the 28 worst political, geopolitical, or economic crises prior to 9/11, Ned Davis Research determined that in 19 cases, the Dow was higher six months after the crisis began. And for all 28 cases, the average six-month return for the Dow following the crisis was 2.3%. Even after 9/11, when the U.S. stock market was closed for several days and then dropped 17.5% upon reopening, the Dow was back to its September 10 level within six weeks. So, while we know that geopolitical crises will always dominate the headlines, history has shown that such crises rarely have a long-term impact on one’s portfolio.