Market Update February 28, 2022

Photo by engin akyurt on Unsplash

Economic data for the week included a slight revision to prior-quarter GDP, a continued gain in house prices, and continued lower jobless claims. However, the Russian invasion of Ukraine dominated most other news.

Global equity markets initially fell sharply last week, in the ramp-up to the Russian invasion, which had been brewing for weeks. However, stocks recovered after the military activity started and rumors of negotiations came. U.S. bonds started strong but fell back as interest rates ticked higher along with a return to inflation worries. Commodities gained across the board, notably in energy and agriculture, due Russian and Ukrainian-specific supply concerns.

U.S. stocks were mixed to higher on the holiday-shortened week, despite sharp day-to-day and intraday volatility. The market closure for President’s Day on Monday may have been fortunate, due to an otherwise global pullback in assets as tensions with Russia and Ukraine continued to escalate, leading to an actual invasion by the end of the week. By sector, defensive and domestically-oriented health care and utilities saw gains of over 2%, while consumer discretionary, consumer staples, and materials fell back by 2-3%, with higher goods inflation uncertainty. Real estate rose over 2% as a bit of a safe haven, despite higher interest rates for the week.

The S&P 500 officially entered -10% correction territory at the close of Tues., Feb. 22, having fallen from a peak level set Jan. 3 (it had come close earlier, on Jan. 27, down -9.8%, which could have been considered a correction, depending how picky one wanted to be about rounding). When correction levels are reached, technical trading responses can exacerbate volatility a bit further, even if fundamental conditions haven’t worsened. In this case, the Russian incursion caused further distress into Thursday, pushing the S&P down to -15% territory briefly, but reversed by the end of the session and led to Friday gains as some rumors of diplomatic negotiations were in the works. The classic market axiom of ‘buy the rumor, sell the news’ seemed as appropriate as ever, along with a flurry of market strategist pieces urging investors to ‘stay the course’, etc. As we’ve noted, the human cost of war and economic impact perceived by markets are often very different—with the shock of military action often fading quickly with conditions becoming ‘less bad’ improving market sentiment. This has been the case for centuries.

Hope of perhaps a ‘limited’ scope of military action and/or breakoff of certain pro-Russian provinces could have represented a more challenging diplomatic issue and lessened sanctions against Russia, but the now broader military offensive has encouraged even reluctant nations to approve sanctions and provide aid (including weaponry). This includes removal from the European-based SWIFT financial transfer system to a large degree, which has been controversial, although there are workarounds for global money transfers. The most complicating element may be Russia’s role as a leading energy and metals producer, as prices for those products have already been driven higher due to prior supply issues. Russia had been strengthening itself from sanction effects from the West over the past decade, by reducing dollar reserves and increasing gold holdings, for example, as well as developing an alternative to SWIFT. However, current sanctions imposed could be deeper and broader than those seen before in response to the outrage over the human cost in Ukraine.

Foreign stocks fared negatively, as expected, due to the proximity of the Russia-Ukraine conflict and European reliance on Russian energy a factor in keeping deeper sanctions at bay. However, as the human cost has become more evident, pressures to apply sanctions have strengthened as well over recent days.

As an emerging market side note, Russian stocks had fallen by about -50% since last October (and over -30% last week alone) as chances for invasion escalated. As we noted in an earlier piece, the Russian equity market represents an extremely small part of most foreign stock indexes (a few percent at best). Hence, most investor portfolios have minimal exposure to the region. Even prior to last week’s events, the Russian equity market was not considered high quality fundamentally, due to an extreme reliance on natural resources, and financial institutions tied to such resources, not to mention concern over state-owned enterprises, such as in China. The timing of the Russian invasion could well be related to recent strength in commodity prices, and reliance of developed nations on them. This translates to the potential for Russian foreign policy and military actions to turn more aggressive when this extra leverage is there for the taking.

U.S. bonds fared well early in the week in classic ‘risk-off’ fashion, but fell back as interest rates ticked higher by Friday—along with rising commodity inflation concerns. Corporate credit spreads widened, resulting in outperformance by treasuries. The stronger dollar pulled down foreign bond returns a bit. This was especially true in emerging market debt, which contains a small Eastern European component that experienced more extreme spread widening due to the proximity of the conflict.

Commodities were generally higher, driven by a variety of price spikes after Russian’s incursion into Ukraine—based on the commodity production importance of the two nations. The price of crude oil rose sharply on Thurs. alone, but ended the week just 1.5% higher at just above $91.50/barrel, in a natural war-based reaction (of higher petroleum prices), but also potential supply disruptions from any implemented sanctions. Brent crude, which is used as a pricing metric for European markets, closed just under $98—after moving over $100—obviously more directly impacted by Russian supply. Commodities have been increasingly discovered by investors this year as one of the few reliable hedges against inflation and idiosyncratic geopolitical events.

Period ending 2/25/20221 Week (%)YTD (%)DJIA-0.03-5.99S&P 5000.84-7.80NASDAQ1.10-12.37Russell 20001.59-8.99MSCI-EAFE-2.49-6.58MSCI-EM-4.85-4.78Bloomberg U.S. Aggregate-0.33-4.00

U.S. Treasury Yields3 Mo.2 Yr.5 Yr.10 Yr.30 Yr.12/31/20210.060.731.261.521.902/18/20220.351.471.821.922.242/25/20220.331.551.861.972.29

Sources:  LSA Portfolio Analytics, American Association for Individual Investors (AAII), Associated Press, Barclays Capital, Bloomberg, Deutsche Bank, FactSet, Financial Times, Goldman Sachs, JPMorgan Asset Management, Kiplinger’s, Marketfield Asset Management, Minyanville, Morgan Stanley, MSCI, Morningstar, Northern Trust, Oppenheimer Funds, Payden & Rygel, PIMCO, Rafferty Capital Markets, LLC, Schroder’s, Standard & Poor’s, The Conference Board, Thomson Reuters, U.S. Bureau of Economic Analysis, U.S. Federal Reserve, Wells Capital Management, Yahoo!, Zacks Investment Research.  Index performance is shown as total return, which includes dividends, with the exception of MSCI-EM, which is quoted as price return/excluding dividends.  Performance for the MSCI-EAFE and MSCI-EM indexes is quoted in U.S. Dollar investor terms.

The information above has been obtained from sources considered reliable, but no representation is made as to its completeness, accuracy or timeliness.  All information and opinions expressed are subject to change without notice.  Information provided in this report is not intended to be, and should not be construed as, investment, legal or tax advice; and does not constitute an offer, or a solicitation of any offer, to buy or sell any security, investment or other product.