Research Update: Russia’s Assault on Ukraine

March 4, 2022

It was just over a month ago that we shared a research update on market volatility to help put into perspective the expected periodic market declines that come with investing in stocks. The underlying circumstances around any market volatility always differ, but they usually center on uncertainty. Today, Russia’s invasion of Ukraine and the significant geopolitical risk that comes with it are the current catalyst for uncertainty, and investors in the global stock markets have reacted wildly.

While the specific reasons that drive any stretch of market volatility are unique, one thing that is the same in these events is that investors react quickly and “price in” new information, often pricing in more impact than underlying fundamentals warrant. Short-term overreactions create opportunities to purchase (or continue to hold) good long-term investments that become cheaper and thus have higher expected returns than before. They also lead many investors to lock in paper losses by selling during a downturn, which is very damaging to long-term returns.

We see no immediate reason to make investment shifts as we assess how Russia’s attack on the Ukraine and the sanctions imposed by the West could affect the global economy and our investment portfolios. The most direct economic impact will be on Russia. Our portfolios currently have very little exposure to Russian stocks (well below 1%) so this risk is of fairly little consequence. Further, an economic recession in Russia is not likely to have much impact on global growth—Russia’s GDP is less than 2% of total global GDP—but restricted gas supplies to Europe and higher energy prices could. Roughly 40% of Europe’s natural gas imports and 30% of its crude oil imports come from Russia. If Russia responds to sanctions by cutting off these energy shipments to Europe it could drive prices higher at a time when inflationary pressures are already leading to tighter money and concerns about slower growth.

Given that markets have already priced in slower economic growth, even as the overall economy has remained healthy, we believe the invasion of Ukraine and any aftershocks are by themselves not likely to push the U.S. into recession. Recent positive economic indicators and the receding Omicron wave indicate this could be another above-trend year for economic growth and corporate earnings. This would support risk assets, such as stocks and credit-oriented bonds. But we also recognize a worse-case scenario in which a complete shutdown of energy flows to Europe is enough to trigger a recession there, with significant negative impacts for the global economy and stock markets. If this were to happen, and a bear market unfolded in the U.S. and Europe, it would likely provide us an attractive opportunity to add to our equity exposure in Europe and/or the U.S.

The near-term uncertainty surrounding the Russia-Ukraine war is significant. It is reasonable to assume things will get worse before they get better. But ultimately, we believe a diplomatic solution/cessation of the fighting will be achieved. In the meantime, markets are likely to remain volatile. But, as always, it would be a fool’s errand for us to invest based on short-term market predictions.

What we do expect is that interest rates are likely to continue to rise this year as we deal with inflation fueled by the pandemic and supply chain disruption. For that reason, we remain unenthusiastic about holding much in core bonds, but global shocks are a reminder of their defensive value in a portfolio. We are more positive on equities, even with the heightened volatility and risk, and we will continue to assess the point at which market declines would make us buyers. In the meantime, we will monitor events closely, and stay the course.

We know that staying the course in the face of anxiety and uncertainty isn’t easy. Our goal is to provide assurance that we are consistently evaluating all significant developments and factoring them into the decisions we make on your behalf. As always, we appreciate the trust you place in us and welcome any questions you may have.  

—Litman Gregory Investment Team

 

Important Disclosure
This written communication is limited to the dissemination of general information pertaining to Litman Gregory Wealth Management, LLC (“LGWM”), including information about LGWM’s investment advisory services, investment philosophy, and general economic market conditions. This communication contains general information that is not suitable for everyone. The information contained herein should not be construed as personalized investment advice and should not be considered as a solicitation to buy or sell any security or engage in a particular investment strategy.
There is no agreement or understanding that LGWM will provide individual advice to any investor or advisory client in receipt of this document. Certain information constitutes “forward-looking statements” and due to various risks and uncertainties actual events or results may differ from those projected. Some information contained in this report may be derived from sources that we believe to be reliable; however, we do not guarantee the accuracy or timeliness of such information.
Past performance is no guarantee of future results, and there is no guarantee that the views and opinions expressed in this newsletter will come to pass. Individual client needs, asset allocations, and investment strategies differ based on a variety of factors.
Investing involves risk, including the potential loss of principal. Any reference to a market index is included for illustrative purposes only, as it is not possible to directly invest in an index. Indices are unmanaged, hypothetical vehicles that serve as market indicators and do not account for the deduction of management feeds or transaction costs generally associated with investable products, which otherwise have the effect of reducing the performance of an actual investment portfolio.
Nothing herein should be construed as legal or tax advice, and you should consult with a qualified attorney or tax professional before taking any action. Information presented herein is subject to change without notice.
A list of all recommendations made by LWM within the immediately preceding one year is available upon request at no charge. For additional information about LGWM, please consult the Firm’s Form ADV disclosure documents, the most recent versions of which are available on the SEC’s Investment Adviser Public Disclosure website (adviserinfo.sec.gov) and may otherwise be made available upon written request to [email protected]
LGWM is an SEC registered investment adviser with its principal place of business in the state of California. LGWM and its representatives are in compliance with the current registration and notice filing requirements imposed upon registered investment advisers by those states in which LGWM maintains clients. LGWM may only transact business in those states in which it is noticed filed, or qualifies for an exemption or exclusion from notice filing requirements. Any subsequent, direct communication by LGWM with a prospective client shall be conducted by a representative that is either registered or qualifies for an exemption or exclusion from registration in the state where the prospective client resides.