It’s a mad, mad, mad, mad world
What the Market? - Feb 28, 2022
A quick note from the authors
The main focus of this week’s update is regarding Russia’s horrific invasion of Ukraine. We recognize that this is a difficult time for many people; our intent as is every week with our newsletter is to provide our readers with the necessary information to understand the impact of major events on both global and domestic markets. This week, our aim is to explain the impacts of the ongoing conflict on the markets and offer suggestions on how to navigate a highly complex and uncertain scenario that will undoubtedly have numerous long-lasting socio-economic implications.
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What the Market?
It’s a mad, mad, mad, mad world, unfortunately this is the reality. There’s no Mickey Rooney or Buddy Hacket, and there’s certainly no fortune to be found. Along with the rest us, Mr. Market is in shock from the events unfolding in Ukraine. Despite a significant turnaround late last week, equity markets have fallen into correction territory (minus 10%-19.99%) and are approaching bear market status (minus 20%). Russia’s military intervention in Ukraine has upended markets and supply chains as production and exports of key commodities come to a halt amid the conflict. While markets have been dealing with the Fed’s new hawkish sentiment, impending rate hikes, and inflation, the escalation in Ukraine has understandably generated further volatility. There is no reason to believe the week ahead will be any different as the situation in Ukraine continues to unfold.
What’s driving the market?
Russian-Ukrainian Conflict: The ongoing conflict will be driving market sentiment this week. The unprecedented uncertainty will keep markets on edge as it casts a cloud over the global economic outlook and upends supply chains in the immediate term. As the conflict wages on, disruptions to energy and food supplies, increased government spending and potential slowdowns in consumer demand due to global civilian fears will likely further global inflation. Markets will most likely be overly sensitive to negative economic data while potentially ignoring any positive undertones.
Let’s break down how this affects global markets:
Surge in Commodity Prices:
Grains/Wheat: No other crop trades in more volume than grain and last week the price per 60-pound bushel hit a nine-year high at $9.32. Russia is the third largest producer of grain after China and India, and Ukraine the ninth. Together, the two warring countries produce more than 25% of the world’s wheat and roughly 30% of global exports. As the war continues on, it has and will continue to cause disruption in both production and exports. The increased pressure on the supply chains will continue to cause price hikes. It is likely that the price of numerous grocery items increases over the coming weeks (e.g., anything containing wheat, vegetable oils, corn, oats, barley, rye).
Oil & Gas: Russia is the world’s 3rd largest producer of oil and gas and one of Europe’s largest energy suppliers (about 40% of total supply). Unsurprisingly the conflict has caused a spike in energy prices. US crude oil surged above the $100-a-barrel mark before settling around $95. Western leaders are hesitant to sanction Russian energy exports due to the potential self-inflicted damage these may cause (see this interactive chart on the EU’s dependency on Russian oil & gas). However, these sanctions remain on the table as they would likely maim Russia’s economy the most. EU leaders will likely need to develop and accelerate their strategy to reduce reliance on Russian energy before dropping the hammer. As the war continues it is likely that numerous pipeline developments will be halted or canceled. Furthermore, the battles may cause damage to Ukraine's energy infrastructure which carries roughly a third of Russian exports to Europe. TLDR: expect energy markets to be highly volatile as supply chains are constrained.
Sanctions: The EU, G7 and other nations have hit Moscow with a slew of sanctions in an attempt to cripple and isolate Russia from the world economic order. The invasion will test the strength of Sino-Russian relationships, as China may play a crucial role as a potential enabler and lifeline to Russia’s longer-term prospects. On Thursday, Russia’s MOEX index closed down 33%, while the ruble sank to a record low. The crash wiped out $70bn off the value of Russia’s biggest companies while foreign corporates are divesting from Russian assets. The Central Bank has responded with a battery of emergency manouvers that include banning foreigners from selling securities to stall further drops in financial markets and hiking interest rates to 20% from 9.5%. Talk about a stress test! Current sanctions have targeted Russia’s financial, transport and technology sectors, as well as state-owned businesses, military organizations, and freezing foreign assets of Russian elites, travel bans and more. One of the most significant of sanctions was the decision to ban select Russian banks from SWIFT (not sure what SWIFT is? Click here).
SWIFT: By cutting off Russian banks from SWIFT, the banks are disconnected from the international financial system. If banks can’t move money it threatens their solvency which could prompt a bank run which could have devastating effects on the Russian economy. Furthermore, it has massive ramifications on the consumer market, if a bank can’t make international payments, it can’t pay for imported goods. Russia stockpiled a large war chest, and developed its own messaging service but we’ll see shortly whether it is sufficient to sustain being disconnected from one of the largest payment system in the world. Further sanctions or banning of the Russian Central Bank could prove to be the biggest economic weapon against Putin’s ambitions.
State of the Union: President Biden faces one of the lowest approval ratings by any President in history ahead of his State of the Union address amidst threats of a nuclear war in Europe. It is a huge opportunity to rally the American population, and one of the few chances he will have to be heard above the chaos that is engulfing the global scenario. Let’s hope for his, and everyone’s sake, he puts it to good use.
Handling inflation just got more difficult: Powell will testify before Congress on Wednesday and Thursday with his plans for monetary policy. The Fed Chair will need to reassure investors that the Fed will be taking appropriate steps to curb inflation risks presented by the Russian-Ukrainian conflict. Analysts will be looking for any potential pivots in the stance towards policy tightening.
What’s an investor to do?
Short-term fears and uncertainty will continue mobilizing capital towards safer assets that tend to benefit from volatility. Investors are moving their money towards safe haven assets such as gold and bonds, in what is known as a flight-to-safety or flight-to-quality. As discussed the geopolitical backlash will undoubtedly have an enormous impact on commodity prices in the immediate term. Consider increasing exposure to commodities and high-grade bonds as a hedge against volatility, inflation and uncertainty.
With greater market uncertainty, it would be wise to move away from riskier, more speculative investments. This doesn’t mean bailing on any and every growth company - it means look for those with both a solid product suite and balance sheet (e.g., avoid drinking the Lemonade).
Equities tend to adjust to new macroeconomic events and despite the current drop, the strong and balanced companies will likely rebound. There is no point in trying to time the market, this may be a strategic time to double down on your most confident plays and strategically buy the dip. Be emotionally and mentally prepared to see your investments sink another 10-20% or more before things get better. Remember, investing is a marathon not a sprint, unless you’re trading.
Keep an eye on the economy
Jobs Report: In addition to a slew of economic data, the February jobs report will be a significant gauge for economic performance and hopefully a positive note for the labor market. Analysts expect 400k jobs to have been created, with an increase in hourly wages and 3.9% unemployment rate.
See here for the full economic calendar
The Curious Investor
No deep-dive this week
Consumer Cyclical: Domino’s, J.M. Smucker, Target, Ross, Dollar Tree, BestBuy, Kroger, Victoria’s Secret, Costco, Sweetgreen, The Gap,
Tech: Zoom, Workday, Salesforce, Snowflake, Okta, Splunk, HP
What we’re vibing:
The Museum of Obsolescence by Tracy K. Smith: Tracy K. Smith was the 22nd Poet Laureate of the United States from 2017 to 2019. This work is from her Pulitzer prize winning collection, Life of on Mars. Possibly WTM’s favorite modern poet, Smith uses the future as a lens to reflect on our society. Without giving the meaning of the poem away, the Museum of Obsolescence in our humble opinion is one of her greatest works.
Robin Williams on the Invention of Golf: It’s hard to believe it’s been eight years since the legend and inspiration passed away. We find ourselves regularly revisiting some of his best works including Robin Williams’ explanation of how golf was created. Still gets us laughing to tears.
A content guide to investing (books, books, books!)
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