It’s been one week since Russia invaded Ukraine. The human tragedy is undeniable and gut wrenching to watch unfold. The long-term geopolitical implications are unclear, but it’s highly likely we’re entering a more fragile state than the one in place over the last three decades. As of this writing, the financial market reaction has been mixed with some assets showing large moves (higher or lower) while other moves have been more muted. Not surprisingly, the largest changes have been in those areas that have a direct link to the war: 

• Russian stock market: -33% from 2/16 through 2/25 and closed ever since
• Russian ruble: -25% from 2/18, having been -35% at some points in recent days
• Oil: +22% since 2/25
• European Natural Gas: +100% since 2/22
• Wheat: +40% since 2/22
• Corn: +14% since 2/22

Elsewhere, risk assets are flat to modestly lower, thus far. Global stocks have moved sideways since the day after invasion. Spreads on high-yield bonds (ex-Energy, which benefits from higher oil prices and makes up a large portion of the high-yield universe) have widened to 360 bps from 340 bps (a sign of slightly higher risk aversion). But overall, and as we always hope to say during crises, the declines have been orderly, with no signs of broad-based panic. 

The coordination and breadth of global sanctions may be one of the more notable aspects of the world’s reaction. Without question, they have been unprecedented, from removing Russia from the SWIFT messaging system, to preventing the Russian Central Bank from deploying its foreign reserves. The acts are aimed squarely at constricting the Russian economy and its ability to finance the conflict.

Why Does (or Doesn’t) War Matter to Markets?

We’re often asked what impact war has on the stock market. To be fair, and not taking anything away from the human tragedy, war hasn’t historically had as much impact on financial markets as it does on the psyches and actual lives of those impacted by it. What investors always try to assess at times like these is whether the conflict will have economic implications. It often doesn’t, but in this case, it likely will.

At the core, there tend to be four transfer mechanisms of war to financial markets: (1) economic activity in the warzone, (2) exports into the warzone, (3) overall financial conditions, and (4) commodities produced in and exported from the warzone. In the Russia/Ukraine conflict, transfer mechanisms (1) and (2) are mostly insignificant. The Russian and Ukrainian economies are small (together they sum to 2% of global GDP) and, as such, exports into those countries by most major economies are immaterial.  However, transfer mechanisms (3) and (4) are more significant.

The concept of financial conditions, admittedly, is not tangible—it’s a measure of how easy it is to get business done and is measured by looking at financial market volatility, credit spreads, and other factors that should capture risk appetite. When investors fear the implications of war, financial conditions tighten and the economy and markets are negatively affected. Finally, the impact of war on commodities is very tangible, particularly in the case of Russia and Ukraine. Russia is a large oil and gas producer (12% of global oil production and 17% of global gas production) and they’re quickly being shut out of the global market which, in part, has caused prices to spike. Further, Russia (18% of global exports) and Ukraine (7%) are both large exporters of wheat, while Ukraine represents 22% of global corn exports. The pronounced move in those commodities and the potential for prices to remain high has notable implications for inflation, as well.

We Don’t Envy Jay Powell

Fed Chairman Jay Powell is in a tough spot. Pre-conflict, he was charged with facilitating a smooth landing for an economy with elevated inflation (6% YoY for January) and decelerating growth (real GDP expected near 3.5% this year, down from 6% in 2021). Enter the Russia/Ukraine war and both inflation and growth are more likely to move in the wrong direction before Chair Powell makes his first move at the March 16th Fed meeting. We noted above why the case for higher inflation is more likely. The case for slower growth is rooted in the case for higher inflation—as the consumer basket becomes more expensive, consumers have less discretionary funds available to spend. As such, economies often slow or even enter recession when inflation becomes an issue.

As such, Jay Powell will need to engage in a delicate balancing act. To be more specific, a balancing act while on a fast-moving train, given the fluidity of the situation in Ukraine. Taken together, we believe he’ll proceed largely as he would have prior to the conflict by initiating the tightening cycle with a 0.25% increase in March and moving judiciously with several more hikes through the year, all the while assessing the facts on the ground to see if he needs to accelerate or slow the pace.

Cybersecurity

Many of you have asked us about best practices for cybersecurity. We’re always happy to provide clients with general best practices for your own Information Security. In terms of what we’re doing at Bernstein to keep your accounts safe, we’ve certainly raised our alert level and have been in close contact with government agencies to ensure we are at the highest level of preparedness. 

Specifically, AB’s cybersecurity and business continuity teams were placed on alert in response to the “Shields Up” alert from the US DHS Cybersecurity and Infrastructure Security Agency (CISA) on Monday, Feb. 14, 2022. Since then, we’ve been working with our security partners to ensure our security sensors are continuously updated with the latest threat signatures. As a member of the SIFMA BCP Committee, we were notified that the SIFMA Emergency Crisis Management Command Center was activated, is monitoring threats, and is requesting information from member firms. As a member of FS-ISAC, we attend FS-ISAC regional threat calls. And finally, we’ve also been actively participating in law enforcement (DHS CISA, FBI) intelligence briefings.

The Range of Outcomes

Investors don’t like uncertainty. Said another way, they prefer a narrow and predictable range of outcomes. We don’t have that today. But importantly, the range of possible outcomes is not solely skewed to the negative (i.e., the “left tail”). There’s a case to be made that the conflict ends in the near term and commodity prices move lower before significant demand destruction sets in. It’s hard to handicap that possibility, but it’s not remote. Together with all the more worrisome economic outcomes (i.e., a recession), again, there are a range of possibilities.  

As such, we wouldn’t generally recommend any meaningful adjustment in asset allocation given one’s own forecast for the near-term economic trajectory. Daily trading figures exemplify how wrong one’s allocation change could become—since the war started, there have been four days in which the stock market moved more than 1% in either direction; three of those days being 1%+ moves higher and one day a 1%+ move lower—go figure. So, hard as it may be (or may become), remember that crises are almost always inopportune times to make a change.

Our thoughts and prayers are with the Ukrainian people as we hope for their safety and for a path to peace.