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What Does the Russia-Ukraine Crisis Mean for Investors?


We have been holding off on commenting on the Russia-Ukraine conflict until some sort of resolution occurred. Lots of things could have happened, and we could drive ourselves crazy worrying about the possibilities. But now something has happened, and it is time to take a look.


Territorial Control Largely Unchanged

But even though something has happened, it’s unclear exactly what that is. The primary fear was that Russian tanks would be smashing through Kyiv, the capital of Ukraine. The reality is that Russian troops are moving into areas already controlled by Ukraine’s Russian separatists. How many troops? We really don’t know. But they are entering territory already outside the control of the Ukrainian government. As of this writing, in terms of actual control of territory, nothing much has changed—yet. And that takes us back to what might happen as opposed to what is happening. The worst fears, so far, are unfounded.


Wall Street Worries

We can apply the same lens to the markets. Something has happened—the S&P 500 is down by 10 percent. But why? Is the Ukraine conflict the reason? Or is the decline due to something else? So far, it looks like Ukraine is not the reason for the drop, despite the fears. So, if that is the case, future damage to the markets from the Ukraine crisis, if any, should be limited.


But what has pulled the markets down, if not the Ukraine crisis? The most likely candidate—one which makes both fundamental and mathematical sense—is higher interest rates. The numbers work like this. Since the start of the year, the yield on the 10-Year U.S. Treasury is up from 1.63 percent to 1.97 percent. That’s an increase of 34 bps, or 21 percent. Higher rates typically mean lower valuations. And, currently, the forward price/earnings ratio for the S&P 500 has dropped from about 22.35 at the end of 2021 to an estimated 19.1, a decline of 3.25 or about 15 percent. After adjusting for earnings beats this quarter, that drop in valuations pretty much explains the drop in the market. And that rationale doesn’t leave much, if any, room for worries about Ukraine. Wall Street, then, seems to be much more worried about Fed Chairman Jay Powell than Vladimir Putin, at least at the moment.


Ukraine’s Impact on Markets

When we look at where stock valuations come from, that makes sense. Corporate earnings remain strong, and are expected to stay that way. Valuations are determined by rates. And neither of these factors are directly exposed to Ukraine. Simply put, Ukraine is a small country and not a significant player in international markets. The direct impact on financial markets should be small, and that is what we are seeing.


Indirect Effects on Markets

We must still consider the possibility of indirect impacts from the Ukraine crisis, which likely will have an effect on the market. The price of oil is a big factor, as Russia is a major energy supplier, and we are already seeing the effects of higher oil prices. This situation will likely keep inflation higher than it would have been. And the effects will be worse in Europe than here, which will hit global growth and sales. These indirect effects are all real, and they could negatively affect the markets going forward.


Potential Positives

If we consider the negative outlooks, we also need to consider the positives. As oil prices have risen, drilling in the U.S. is already picking up again. This factor will both constrain oil price rises and help economic growth here. If, however, growth does slow significantly, so will inflation. This scenario could slow down the Fed’s interest rate increases. It could also bring rates back down—to the benefit of stock valuations. And, at some point, there is a real possibility that the Russia-Ukraine crisis will pass. This outcome would leave us in a more stable situation with lower levels of fear, which would push economic growth and the markets back up. Bad things could and likely will happen, but so will good things, often as a direct result of the bad things. Either way, the impact on markets, over time, will be limited.


Short-Term Outlook

Make no mistake, though, things could get worse in the short term. Putin could decide to invade the rest of Ukraine, sanctions could be ramped up on Russia, and Europe could take a real hit. But all of these are only more extreme versions of what we are already seeing—and weathering. And the potential offsetting good effects only become stronger if the crisis gets worse.


The fear is that, somehow, the Russia-Ukraine crisis will sink the markets. But for that to happen, either earnings have to drop (which is not likely to any significant degree) or valuations will have to drop (which would be constrained over time). People could panic, but so far that has not happened. Even if some investors do panic, market panics pass. We have seen this happen several times during the pandemic.


Fundamentals Remain Strong

Market volatility is normal, but the truth is that the decline we have seen so far is much less than might have been expected. That is due to the strength of the fundamentals, which should continue. The U.S. economy continues to grow, our country remains open, and, even as the geopolitical worries ramp up, our medical worries are declining. Will the Ukraine crisis have an impact? It certainly will, on a geopolitical level. On an economic and market level, though, that impact is and will be much less.


Key Takeaway

That is the key takeaway here. This is a real crisis, but it is not about economics or markets. As such, the impact of the Russia-Ukraine conflict on your investments will be limited and likely short in duration, as we have seen with other crises.


Do we need to pay attention? Yes, we do, but thoughtfully.

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Insight Financial Horizons is located at 150A Andover Street in Danvers, MA 01923 and can be reached at 978.774.2266. Securities and advisory services offered through Commonwealth Financial Network®. Member FINRA, SIPC, a Registered Investment Adviser.

© 2022 Commonwealth Financial Network®


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