What You Need to Know
- Vladimir Putin may have underestimated the consequences of invading Ukraine.
- Inflationary pressures are likely to ease in the second half of 2022.
- Despite a highly uncertain near-term outlook, long-term prospects for economic growth and equities remain favorable.
Russia’s invasion of Ukraine is a tragic event that amplifies uncertainties creating market volatility. The path of conflict in Ukraine has far-reaching implications, adding to already high uncertainty about economic growth, inflation and central bank policy.
Europe and Russia face more direct investment implications than the U.S. and U.K.
Nearly 40% of Europe’s natural gas is imported from Russia; Germany relies on Russia for more than 60% of its natural gas needs. Rising natural gas prices and potential supply disruptions represent bad news for European countries already struggling with inflation. In contrast, the U.S. and U.K. rely far less on Russian energy exports.
The invasion of Ukraine may be costly and risky for Russian President Vladimir Putin. Russia’s economy is valued at approximately $1.5 trillion, roughly the same size as Brazil’s, and is highly dependent on energy exports. Western sanctions create headwinds and isolate the already-struggling Russian economy.
According to TS Lombard’s Christopher Granville, “the option of retaliating by reducing oil and gas exports will be outweighed by the imperative of continuing to tap the revenue bonanza as the best way to foil the intended effects of the Western sanctions.”
Popular support for Putin in Russia may fall if the invasion of Ukraine becomes a protracted conflict with rising Russian casualties. He may have underestimated the consequences of the invasion, such as the movement of Sweden and Finland closer to NATO and commitments from Germany and other European countries to spend more on defense and take bolder steps to obtain “energy security.”
Although the bar to invading Ukraine may not have been too high to prevent action, the bar to staying in a protracted conflict in Ukraine may become too high for Putin. Regardless of the outcome in Ukraine, it is likely that Russia’s economic and military constraints will keep Putin from extending military conflict to NATO members bordering Russia and Ukraine.
Equities were slumping before the invasion, with speculative segments of the market down significantly from 52-week highs.
Fears of an overly aggressive Federal Reserve and high inflation dominate the headlines, but fears of higher interest rates may not be the entire explanation for the market correction. Investors may also be reevaluating growth rates and total addressable markets for many companies.
“COVID winners” that benefited from social distancing such as Peloton and Netflix may face a smaller end market or greater competition than was estimated at the height of the pandemic. The combination of a smaller end market and a rising discount rate for far-in-the-future earnings is bad news for many companies that traded at a pandemic premium.
Investors may be overestimating how quickly the Fed will move to normalize monetary policy.
The economic feedback loop is an important factor in Fed policy, with the central bank likely to move more slowly if growth or inflation slows. Inflationary pressures are likely to ease in the second half of the year. Goods spending should fall from pandemic peaks. New and used auto prices are among the contributors to goods inflation that should fade in importance in the latter part of 2022.