Russia/Ukraine Crisis and Inflation Risks
This week began with “Twosday,” 2-22-2022, and may have portended the two-headed serpent attacking the stock market this week: Russia’s invasion of the Ukraine, and U.S. inflation. After many head feints, Russia finally launched their attack in the Ukraine. While the situation will continue to play out in the months ahead, the history of similar situations suggests the markets are likely to find relative stability in the near term as the crisis matures. The markets had already been anticipating this but fell dramatically this morning as what was anticipated became reality. The broader U.S. stock market is now clearly into correction territory with losses since the beginning of the year of over 10%. However, the real damage is being felt in the technology sector with the tech-laden NASDAQ crossing the line into bear market territory with losses over 20% since its recent peak. The troublesome headlines and market losses clearly feed what psychologists call a “recency bias” where we overweight new information and events. This causes us to lose our long-term focus and to forget facts such as the 100% stock market return from 2019-2021.
How should investors respond when emotional reactions to market volatility and recency bias conspire to take our eye off the ball? One way is to put current events into perspective. Russia’s incursion into Ukraine wasn’t the first such armed conflict and certainly won’t be the last. Looking at similar conflicts over the last 90 years the median U.S. stock market loss was 7.9%, while one month later the market had a gain of 1.1% and twelve months later was up 10.2% (source: BCA Research). A specific example still in memory for most of us would be the Iraqi invasion of Kuwait on August 3, 1990. On a total return basis, this event saw the S&P 500 lower by 6.1% a month later, down 10.2% three months later, recovering a bit at six months to just 5.3% lower, back in positive territory at 0.7% higher nine months later, and up 16.2% a full 12 months later (Source: Bloomberg). These statistics related to geopolitical crises distant from US borders remind us of the importance of keeping a long-term perspective and sticking to our investment plan in pursuit of our long-term goals. The long-term focus helps us to keep the emotional reactions which all humans experience from supplanting fact-based, disciplined decision-making.
The other and perhaps larger head of the Twosday serpent is inflation. With prices increasing 7.5% year-over-year in January, it is appropriate to be concerned about the associated risk. Inflation is an insidious enemy that eats away at the purchasing power of our money over time. In the recent Consumer Confidence Survey, it was the prime topic of concern. The Federal Reserve has also become focused on it and will likely begin increasing interest rates next month. While natural resources such as gold and oil can help to combat inflation, the primary weapons against it are growth assets. These include stocks and real estate whose prices have historically risen in value over time at a rate higher than inflation. While we may want to get out of stocks and sit on the sidelines during the Russia/Ukraine crisis, doing so would be far more likely to harm our efforts to fight inflation beyond the near term and into the long term where it does the most damage. We strongly advocate sticking to the investment plan and reaping the risk mitigation benefits of diversification as a way to play the overwhelmingly higher odds of greater long-term success.
During this period of uncertainty, your investment management team is continuing to monitor these and other events with an emphasis on managing your portfolios with a long-term focus. Please feel free to contact us if you have any concerns or would like to review your personal situation.
This market update was written by Broadway Bank’s Portfolio Managers.