A Letter from the Investment Committee, February 24, 2022:
It certainly wasn’t the news that we wanted to wake up to this morning, which was the confirmation that Russia has invaded its neighboring country Ukraine. The initial reaction for many is to be scared and nervous, which is natural given the uncertainty surrounding geopolitical conflicts that ultimately turn aggressive. What I’m going to discuss below is pertinent to portfolios and the global economy, but we don’t want to sound insensitive to the real-world implications this has for many humans in eastern Europe. It’s an unfortunate situation that we hope is resolved swiftly and peacefully. With that said, below are our thoughts on the current situation:
Why is this happening?
This is a complicated question that goes back a long time to the existence of the Soviet Union. While we’re not experts in this area, it has become clear that Russia does not want NATO expanding to Ukraine and for western influence to be at its borders. As I said, there is a very long, complicated history of eastern European politics that extends beyond our expertise.
What is the impact on the global economy and investment portfolios?
We believe the direct impact of the conflict will be quite contained. At this point, Russia accounts for about 3% of global GDP while Ukraine is less than 1%. We would expect the bigger impact to be European trade relations and rising energy prices. The good news, if we can really call it that, is that exports from major European countries to Russia are pretty small. The concern for Europe is energy, where a decent amount of their supply comes from Russia. We’ll have to see the types of sanctions that are put on Russia and the impact of energy supply to the region. We would expect other areas of the global economy to step in to help facilitate energy supply if needed.
We do believe that most of the economic volatility will be contained to Europe at this time. At this time we don’t see the conflict as having a huge impact on U.S. economic growth or corporate earnings. We still see both of those as strong and supportive of a healthy domestic economy.
As we’ve historically seen from geopolitical conflicts, the initial impact is usually felt the most. If we look back at major events, such as Brexit (2018), Crimea (2014), and the Iraq War (2003), the initial market reaction is negative but then rationality takes over and markets have historically rebounded in subsequent months as they evaluate the true market impact. Given the fact that this crisis doesn’t have a major direct impact on our domestic economy and corporate earnings, we would expect the same. What we do need to keep an eye on is how this affects, if at all, the plan for the Federal Reserve raising rates several times this year. We don’t expect it to change much, especially since the market is pricing in anywhere from 5-7 increases throughout 2022. We look at the market pullback from the last two months as a typical short-term overreaction and still hold our optimistic view on the economy moving forward.
I just want to reassure our clients that we’re always on top of market events and continually discuss internally how they adjust our market view, if at all. Markets have historically corrected (pulled back by at least 10% from their high level) quite frequently, probably more than most individuals remember. The prudent thing to do, in our opinion, is to remain disciplined, proactive, and to tune out the noise. Asking yourself whether or not the current event(s) fundamentally change our outlook or long-term plan is a prudent thing to do, and will be a good guide to rational decision making. We believe this will pass, but not without a whole lot of noise from mainstream news outlets. If there is ever anything we can do, please don’t hesitate to reach out as we’re always here to help ease your mind. Thank you for the trust you put in the Diversified team.
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