by: Matt Krauss, CFA, Managing Director

In the early hours of February 24^th, after weeks of political posturing, military buildup, and Russian recognition of two separatist regions of eastern Ukraine, Russia commenced a full-scale invasion of Ukraine.  Russian leader Vladimir Putin rationalized the decision by saying the expansion of NATO’s alliance along Russian borders crossed a “red line.” Russia’s stated intent is to demilitarize the country of Ukraine and install a government devoid of western influence.  These events reflect one of the most serious security threats to Europe since World War II.

 

Putin reiterated Russia is not interested in occupying Ukraine, but the reaction from markets across the globe indicates this statement is falling on deaf ears.  Oil prices spiked on the news, approaching $100 a barrel in the U.S. and eclipsing that figure in Europe.  Similarly, European natural gas prices increased upwards of 50% given Russia supplies a large portion of Europe’s power needs.  While stock markets in Europe sold off more than 3%, U.S. market declines were more muted.  Traditional safe havens such as government bonds, the U.S. dollar and gold rallied.  Anecdotally, Bitcoin and other unproven safe havens continued their meaningful year to date declines.

 

While the direct economic and earnings impact to individual corporations is likely very low, there is the potential for second derivative impacts to be more significant.  These include:

 

• Rising input costs and energy prices impacting corporate profit margins
• Declining consumer sentiment slowing economic growth
• Investor pessimism, increased risk premiums and volatility in global markets causing declines in asset prices

 

In many ways, we always prepare for turmoil at RGT, especially the kind we are seeing today.  Our core investment philosophy centers around balance, flexibility, and diversification.  We did not abandon the safe havens of fixed income, such as municipal bonds or agency mortgages, despite their relative underperformance versus stocks over the past few years.  We added exposure to gold within the past two years precisely for the sudden events and volatility that we are experiencing today.  Finally, we maintain a globally diversified portfolio which mitigates portfolio declines, improves long-term compounding, and reduces the risk of a specific market shock.

 

During uncertain periods such as this, we also have the additional potential lever of being opportunistic.  Rebalancing and tax loss harvesting are two possible examples of using market volatility and turmoil to sell what has worked and buy what is cheaper while also reducing current and future tax bills.  It is also important to remember that current market declines naturally increase forward returns.  Putting cash to work at cheaper prices has the potential to generate more attractive returns relative to what was available recently.

 

Throughout decades of market history, geopolitical events have consistently stress tested markets.  Investors’ initial reaction is often fear which leads to corrections and bear markets.  This is what we are seeing now.  However, history has demonstrated over the long run, markets tend to be resilient and digest unexpected news over reasonable time frames.  The initial fear often proves to be an unwarranted overreaction while opportunism and level headedness has historically led to better outcomes and more compelling portfolio returns over long periods of time.