Russia, Ukraine and YOU

Russian aggression into Ukraine has prompted a dusting-off of the term “geopolitical risk”. Beyond accepting the massive uncertainty surrounding this situation, what does the conflict mean for you and your money?

In the largest sense, there could be far-reaching economic consequences associated with the hostilities, which could halt or slow down the broad, post-COVID economic progress the world and the U.S. have seen over the past two years. (As a reminder, the U.S. economy (as measured by GDP) contracted by 3.4 percent in 2020 and expanded by 5.7 percent in 2021.)

Economists are busy trying to predict by how much growth could slow down overall (currently, they are penciling in a reduction of global growth by nearly one percentage point to 3.3 percent), but the immediate impact of the Russian action, along with Western sanctions, would be most severe for Ukraine and Russia. Unfortunately, as we have learned over the past two years, snags in one part of the world can disrupt the globe.

Russia is a big exporter of everything from petroleum products (oil and natural gas) to agricultural commodities, like wheat, (Russia and Ukraine account for between 25-30 percent of global wheat exports, and around 80 percent of global sunflower seed), to metals like aluminum, platinum, and palladium (used in the production of semiconductor chips), especially to Europe, Russia supplies about 40 percent of natural gas and 25 percent of oil to the continent.

The Russian invasion into Ukraine also means that worldwide supply chains could slow down, either due to material shortages, potential disruption to production, logistics route and capacity constraints, or potential cybersecurity breaches. Taken together, this could cause companies to temporarily slow down the pace of their capital spending and more importantly, will add to inflation pressures this year. After clocking in at 40-year high of 7.5 percent, economists now predict that CPI could reach 9 percent before retrenching.

“The biggest impact is likely to come through commodity prices,” according to Neil Shearing, Group Chief Economist at Capital Economics. Although the U.S. does not rely on Russia for oil, energy markets are global, so any disruption to one part of the world would be felt here. Crude oil prices had already soared above $90 per barrel on a post-COVID surge in demand, which caused prices at the gas pump to rise by 40 percent from a year earlier. The average for a gallon of regular gasoline stood at $3.54 the day before the invasion, according to AAA. With prices up by $0.21 from a month ago, and $0.88 from a year ago, consumers were already reeling from the impact of higher oil.

There had been some hope that American frackers could step in and increase their production to alleviate the strain, but that would require a big change of strategy for many players in the industry, and experts say that the time and logistics of getting U.S. product to Europe amid the afore-mentioned supply chain clogs, could be problematic. Similarly, there has also some talk that a renewed nuclear deal with Iran could help ease the strain, because that country is sitting on about 80 million barrels of oil in storage. Again, this would take time, so no quick fixes.

Shearing warns “In a worst-case scenario, we estimate that oil prices could rise to $120-140 per barrel,” which could add another $0.50 to the price at the pump, and around “two percentage points to headline inflation in advanced economies this year, with Europe hit particularly hard.”

Beyond the impact on gas prices, the inflationary effect of the conflict means that the Federal Reserve is still on track to raise short term interest rates at its March meeting, as previously telegraphed. Inflation as measured by the Fed’s preferred gauge (the core personal consumption expenditures (PCE) index) was up by 5.2 percent in January from a year ago, which was the largest annual increase since April 1983. Including food and energy prices, headline PCE was up 6.1 percent, the hottest pace since February 1982. While these measures are lower than the CPI, they are well in excess of the Fed's 2 percent target.

Investors had already been concerned about higher rates, but the Ukrainian situation adds another level of worry to the picture. That means that we are going to see more volatility in financial markets, evidenced by the action of the week of the invasion, where the S&P 500 dropped into a correction (down more than 10 percent from the January 3rd high) and the NASDAQ Composite temporarily flirted with bear market territory (down more than 20 percent from the November peak).

You can help yourself by taking a deep breath and getting some perspective. Thankfully, the economy and labor market are coming into this period with strength and while it is undoubtedly tough to endure gyrating account values, investors have just enjoyed three phenomenal years of market performance (the S&P 500 was up nearly 27 percent last year, 16 percent in 2020 and 29 percent in 2019). Before you scratch the itch of trying to “do something” to prepare your portfolio for the Russia Ukraine conflict, a stern warning/friendly reminder: when you see big moves in the market, sit still and comfort yourself with your diversified portfolio.