Initial Thoughts on the Ukrainian Conflict
Excerpted from an email sent to LNWM clients by CIO Ron Albahary, CFA® on Feb. 24, 2022:
While this note will focus on your portfolios, let me start out by saying our hearts and our thoughts go out to the people of Ukraine today. We hope this is a very short-lived conflict and peace returns to the European continent as quickly as possible.
Given the escalation in the Russia-Ukraine conflict last night and the negative subsequent reaction from investors, we wanted to provide you with a communication framing the situation. Russia has moved aggressively as it seeks to reduce NATO’s presence in eastern Europe and increase its own dominance in the region. Russia’s bombardment of military installations throughout Ukraine coupled with cyberattacks have increased the prospects that Putin’s ultimate aim is to shift the balance of power in Europe to what prevailed during the Cold War. In response, Western powers are formulating additional economic and financial sanctions against Russia. While extensive, these sanctions are not likely to impact the global economy in a material way.
The greater risk, if the conflict continues to escalate, is ongoing disruption to energy, food and the overall global supply chain, which is already fractured due to the global pandemic. This risk, if it plays out, has the potential to exacerbate inflationary pressures and challenge global growth. From a more positive perspective, threats to global growth tend to create a flight to safety (i.e. high-quality bonds) thereby lowering yields and can cause the world’s central banks to defer their current bias toward increasing interest rates and curtailing economic stimulus.
As wealth planners and long-term investors over many decades, we have shepherded clients through a variety of shocks to the capital markets — wars, a credit crisis, a pandemic, just to name a few. We draw on all that experience as well as market history to provide context when downside volatility fuels investors’ emotional and cognitive biases. While each conflict is different, and this one has the potential to change the complexion of Europe, geopolitical market shocks since the 1960s have tended to be short-lived.
Market Performance in Context
Recent market weakness, while rapid, should be put into perspective. It is fair to say the wind was at our backs for the past three years, with cumulative returns of 100% for US large-cap equities and 75% for global equities (through 2021).
As I am writing this, the S&P 500 is down roughly 11% from its 52-week high, putting it back to where it was in June 2021. Consider that since World War II, the S&P 500 has experienced 28 corrections (drops of 10% or more from recent high), usually one every two years with an average decline of 13%. The average performance one year later: 9.3%. (Source: Dow Jones Market Data).
Other major US indexes have performed worse recently, but still in keeping with their historical averages.
Interestingly, foreign equities outside of Europe have performed relatively well, reaffirming the value of diversification. Emerging market equities are down 6.5% so far in 2022, while global stocks are down around 10%.
No one can predict how this conflict will evolve. In the meantime, we believe the greatest risk to achieving your goals is not downside market volatility; it’s making a suboptimal, emotionally driven investment decision. Please keep in mind these things:
Adherence to your wealth plan and the strategic allocations in your Investment Policy Statement is key. These are the components of your personal “business plan” and were built for these moments; they provide you and us with a long-term, unemotional investment blueprint for achieving your goals. If you have excess cash and/or are underweight equities, and can tolerate drawdown risk, speak to your LNWM advisor about starting to incrementally dollar-cost-average into this sell-off.
Diversification is a risk mitigator. We have infused LNWM portfolios with exposures designed to provide stability in risk-off times like these. This includes core fixed income, an allocation that has been questioned by many during the strong stock market of the past three years but is serving its purpose as equity markets decline. We construct portfolios very thoughtfully with each exposure expected to play a distinct role in diversifying the types and level of risk being taken as well as the opportunities they are targeting.
Good portfolio performance over the long run is based on occasionally experiencing losses in the short run. We don’t know how deep or how long the current sell-off will last – we cannot possibly know. We do know that sticking with a disciplined approach to investing (and not allowing downside market volatility drive bad decisions) works.
There are likely to be more opportunities developing, even as investor psychology acknowledges an elevated level of uncertainty. As we sort through the confusion brought on by recent events, we feel confident in our approach to risk management, the universe of opportunities resident in portfolios and new ones we are exploring.
Russia’s attack on Ukraine is an evolving situation—one the entire world is trying to assess in terms of the short-term and long-term implications for the global balance of power and the global economy. Our 13-person investment team is engaging with our asset managers from around the world tapping into their expertise and access to information to glean insights on a real time basis. As events unfold, we will continue to update you.