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What Russia-Ukraine War Means for Investors and Advisors

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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.

Wage pressures may also slow before year-end. Labor participation remains below pre-pandemic levels. Given continued progress containing and treating COVID-19, labor participation should continue to rise, helping to ease wage pressures.

The likely long-term outcome is for inflation to remain above pre-pandemic levels but fall sharply from today’s levels. The Fed may well declare victory if inflation falls to the 2.5%-3% level that many consumers and investors expect.

Advisors should avoid overreacting to geopolitical events.

Geopolitical events provide important but imperfect guidance. Equities were higher six and 12 months after events such as the Iranian hostage crisis, Soviet invasion of Afghanistan, Iraq War, and 2014 Ukraine conflict.

Although the impulse to trade is highest in times of heightened uncertainty, market volatility tends to be most damaging to forced sellers. Advisors should encourage clients to maintain enough liquidity in the form of cash and short-term, high-quality holdings to provide safety and liquidity in turbulent times and avoid having to sell stocks at an inopportune time.

Despite a highly uncertain near-term outlook, the long-term prospects for economic growth and equities remain favorable. Long-term investors should stay invested in stocks while looking for opportunities to take advantage of market dislocations that have caused some good companies to sell at a discount to their long-term prospects.

In the short term, U.S. equities are a likely safe haven. Europe’s geopolitical and energy insecurity will weigh on sentiment and corporate earnings until the path of conflict in Ukraine becomes clearer.

European and emerging markets stocks, however, trade at multi-decade lows relative to U.S. stocks, so the potential for a relief rally is high. Cyclically oriented stocks offer value if the war in Ukraine is contained, an energy crisis is averted in Europe and China’s policy-easing gains traction.

Longer-term bonds remain risky investments, given elevated inflation and tighter policy from most central banks; shorter-term bonds hold more pockets of value than was the case much of last year.

Daniel S. Kern is chief investment officer of TFC Financial Management, an independent, fee-only financial advisory firm based in Boston. Prior to joining TFC, Daniel was president and CIO of Advisor Partners. Previously, Daniel was managing director and portfolio manager for Charles Schwab Investment Management, managing asset allocation funds and serving as CFO of the Laudus Funds. Daniel is a graduate of Brandeis University and earned his MBA in finance from the University of California, Berkeley. He is a CFA charterholder and a former president of the CFA Society of San Francisco. He also sits on the board of trustees for the Green Century Funds.


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