Implications of War in Ukraine
Putin has launched the war into Ukraine that the West has been trying to deter for some time. We consider some of the implications.
The West will respond very quickly with widespread sanctions, including cutting off Russian transactions from the Swift system that processes international transactions and halting imports from Russia to the extent possible. It is critical for the West to convey to Russia that the price it will pay is very high, so Putin reconsiders how far he is willing to push his invasion. It is clear such action is too late to serve as any kind of deterrent. Rather, it would be harsh punishment to alter Putin’s behavior.
Europe’s dependence on oil and gas imports from Russia is its Achilles Heel. Expect U.S. and Middle Eastern exports of oil and gas exports to ratchet up to the degree allowed by capacity constraints. Energy prices have already risen sharply and they will remain elevated until markets adjust.
Russia and Europe are likely to experience recessions. Russia will see an immediate decline in exports. Higher energy prices in Europe will cut into household spending, but likely, only modestly. European citizens will likely curtail energy use to make supplies last longer. And governments will be spending more for defense and humanitarian support for Ukrainians. Western companies that source various raw materials from Russia, such as aluminum or cobalt will pivot to other sources to the extent possible. It remains to be seen if China acts as an intermediary to help Russia minimize its loss of access to export markets.
The timing of this event complicates the efforts of central banks in trying to rein in inflation pressures. It is certain that inflation pressures will rise directly due to higher energy costs and also indirectly due to disruptions to trade flows. Neither the Federal Reserve nor the ECB will accept a rise in inflation that is allowed to become embedded in their respective economies. So, existing low interest rate structures cannot be sustained, even if the conflict in Ukraine last for some time. Thus, it is our judgment that the Fed is still likely to lift rates by 0.25% at its upcoming March meeting. But aggressive anti-inflation steps are extremely unlikely, since policymakers will avoid being disruptive.
Policymakers and investors will be dealing with a high level of uncertainty for the near term, as developments unfold. A recession in the U.S. remains unlikely, although growth is likely to slow over the next quarter or so. We are reviewing holdings to determine if some have overreacted to the latest political developments. We will, of course, continue to communicate our thoughts as events unfold and we react with the portfolios we manage.
Markets largely have ignored recent conflicts related to the Middle East and Iran. As highlighted in this commentary a war between Russia, Ukraine, and NATO allies, may have a more severe impact, especially on commodity prices in the near-term. However, over history the U.S. stock market and economy have enjoyed strong growth despite the negative short-term impact from these types of events. In the nearly 20 years since Sept. 11, 2001, the S&P 500 index has risen nearly four-fold, despite periods of steep declines, including the 2007-2008 financial crisis. And the U.S. economy has enjoyed several long expansions during that period amid major disruptions that include the Great Recession from December 2007 to June 2009, and the economic fallout from the COVID-19 pandemic. This is why staying invested is always a better strategy than leaving your investment plan during down markets. Exiting investors must then make a second almost certainly flawed decision of when to return.
The foregoing content reflects the opinions of Advisors Capital Management, LLC and is subject to change at any time without notice. Content provided herein is for informational purposes only and should not be used or construed as investment advice or a recommendation regarding the purchase or sale of any security. There is no guarantee that the statements, opinions or forecasts provided herein will prove to be correct. Past performance may not be indicative of future results. Indices are not available for direct investment. Any investor who attempts to mimic the performance of an index would incur fees and expenses which would reduce returns. Securities investing involves risk, including the potential for loss of principal. There is no assurance that any investment plan or strategy will be successful.