Our hearts go out to those impacted by the situation abroad. Coming into 2022, we were prepared for an uptick in volatility in financial markets. As outlined in our Q1 2022 Quarterly Edge, the staying power of inflationary pressure, a pivot in monetary policy, health of the consumer, and investor risk appetite all pointed to greater uncertainty on the horizon. To say that the Russian invasion of Ukraine adds to the uncertainty of the financial markets is an understatement.
While there is currently little direct impact on our daily lives domestically, it is clear that the conflict could have far-reaching ramifications as we move forward. There have long been ideological differences between Russia and the developed West. Russia’s invasion of Ukraine is the second event in three years that has exposed a shortcoming of a deeply globalized economy. So, for us in the West, what could be the consequences of Russia’s actions?
Russia’s invasion of Ukraine and the West’s ensuing response could exacerbate the supply/demand imbalance that lies at the core of the global inflation surge. Russia runs at a current account surplus, meaning its economy exports a greater value of goods and services than it imports. Reducing trade with such a country via sanctions and boycotts means that the rest of the world needs to produce a larger share of what it consumes. Further, rerouting trade routes around Russia and Ukraine will take time and lead to higher shipment costs. On the headline, a shift appears modest as Russia only accounts for under 2% of global goods trade and GDP, but the more specific knock-on effects could serve to intensify and prolong our current inflation situation.
Source: IMF, Goldman Sachs Global Investment Research
Russia is a meaningful player from an energy perspective, where the country accounts for 11% and 17% of global consumption of oil and natural gas, respectively. Domestic imports of Russian energy are not a significant piece of the equation, but Russia’s natural gas accounted for as much as 40% of Western European consumption. Regardless of how it shakes out, any rearrangement of energy sources would pressure prices to the upside, which would subsequently detract from GDP (both domestic and abroad) as consumers bear the burden.
Source: Goldman Sachs Global Investment Research
Keep in mind that any sustained elevation in oil prices would come at a time in which the U.S. economy is already running hot. 770,000 jobs were added last month, and the unemployment rate is at a recovery low of 3.8%. However, the total number of jobs dramatically exceeds the total number of workers, and real wage growth (i.e., after inflation) is negative. Tighter monetary policy will aim to tamp down inflation, but the downside risks to growth that stem from an adverse shock to the global economy may ultimately hold the Fed back from aggressive tightening. The Fed is late to the game, and to the extent that growth materially slows or financial conditions tighten dramatically on the back of the situation in Ukraine, the Fed may be persuaded to pause, or even reverse, rate hikes before too long. Expectations for domestic GDP growth coming into 2022 were already more moderate relative to the ~7.0% seen in 2021, and estimates across Wall Street have steadily revised downwards. To be clear, recession risk arises in an environment composed of aggressive monetary tightening and slowing growth.
Geopolitical events are notoriously difficult to navigate as it pertains to financial markets. Reliable information is scarce, uncertainty is high, and the range of potential outcomes is troublesome. Nothing is certain with regards to what a resolution to the conflict in Ukraine will ultimately look like, and we have no crystal ball that will tell us when that resolution will occur. However, we know that investing based on emotion is a losing proposition. Just because the situation in Ukraine appears bleak, trying to time the allocation of capital based on a resolution will almost undoubtedly yield a lesser outcome than spending time ensuring that a portfolio is well-positioned to balance resilience and appreciation.
Dialogue is key in times of uncertainty, and historically speaking, it is periods such as the one we find ourselves in today that can reveal the true value of partnering with a firm like Blue Chip Partners. While volatility has taken center stage thus far in 2022, market participants should not ignore the fantastic business results that have come from domestic operators in the first couple months of the year.
If you have any questions, please reach out to a Blue Chip advisor for guidance. We are here to help.
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