The Russian invasion of Ukraine added another headwind to what has been a painful and volatile year so far on Wall Street.
As of the closing bell on March 4, the S& P 500 was down 10% from its record close on Jan. 3. It briefly fell into correction territory the week of Feb. 21 for the first time since the market’s 2020 pandemic-induced plunge.
Financial markets have been struggling with inflation at a 40-year high, along with the prospect of rising interest rates. A quarter-point hike in the Fed’s benchmark short-term interest rate is widely expected later this month.
Add to that Russia’s invasion of Ukraine, which has sent oil prices soaring on fears of supply disruptions. U.S. crude oil rose more than $8 a barrel last week to more than $115 a barrel, its highest close since 2008.
Surging oil prices, in turn, have fanned inflation, since fuel is tied to the manufacture and delivery of nearly every product on the planet. Inflation had already been climbing due to pandemic-induced supply shortages. The hostilities have added to the upward pressure on other commodity prices as well, all indicators of inflation. Wheat and corn prices are up more than 20% so far this year. Ukraine is a key exporter of both crops.
But money managers say it’s not time to panic. While it would be surprising if the situation in Ukraine were resolved anytime soon, there are several moves advisors can make for their clients to at least cushion the decline in the stock market.
“Most strategists are suggesting we stick with value stocks, but valuations have pulled back significantly for growth and technology names,” said Michelle Connell, owner of Portia Capital Management in Dallas.
She said a number of tech stocks look compelling, singling out Adobe, and said there are some semiconductor companies selling at valuations that warrant a 15% to 25% increase from current prices, such as Nvidia and Taiwan Semiconductor.
Connell said she has seen value managers start to pick up technology names that once were too expensive and long/short managers buy stocks of companies that they had previously shorted.
She also said small-cap stocks, especially small-cap value stocks, are selling at large discounts, as are international stocks, especially in Asia, specifically India. Emerging markets are also a good move right now, she said, after a dismal 2021. The iShares MSCI Emerging Markets exchange-traded fund was down 12% in the second half of 2021, a year that saw a 22% rise in the S&P 500.
Commodity prices were already up sharply because of worldwide inflation caused by the pandemic, she said, but the war will send oil and natural gas prices even higher, as well as the prices of grains and certain metals.
“I’ve heard people talk about the possibility of $200 a barrel oil,” said Phil Toews, CEO of Toews Asset Management in New York.
“We can’t exclude the possibility that there will be some resolution to this geopolitical conflict,” he said. “If Putin perceives this could be a bigger deal than he expected, he could back off, and that would be a short-term positive for the financial markets. But that is a low probability. The higher probability is that we enter into an intractable malaise geopolitically.”
The implications for energy prices are obvious, he said, with Russia being the world’s third-largest producer of liquid fuels, according to 2020 figures from the U.S. Energy Information Administration.
Toews recalled 2018, when the Dow industrials and S&P 500 fell for the first time in three years and the Nasdaq snapped a six-year winning streak.
“That was based only on the prospect of rising rates and the fact that (Federal Reserve Chairman Jay) Powell had said he was going to continue to raise rates despite the markets being weak,” he said. “Today we are still on course for a rate hike despite the market falling.”
Toews said for a portfolio that is 60% stocks and 40% bonds, he would recommend taking half of the stock portfolio and putting it in hedged equity funds — high-conviction tactical funds or ETFs — or having options to hedge against market downturns.
“These are available on every platform,” he said. “Buffer ETFs, hedged equity mutual funds, and as a hedge against inflation, an unconstrained bond fund, or TIPS (Treasury Inflation Protected Securities). And this is not to necessarily make gains but to reduce losses.”
On the subject of bonds, Matt Dines, chief investment officer and co-founder of the fixed income and options strategy firm Build Asset Management in Seattle, said he expects to see investors, not surprisingly, cutting their exposure to Russian bonds.
“With Russian banks out of the SWIFT system (which enables the international transfer of money), for dollar-denominated Russian bonds, you’re severing the ties for those assets to be paid forward. There’s more downside risk of them not paying than of them paying,” he said.
Dines called energy “the queen on the chessboard. Russia is the third-biggest producer of oil and natural gas exports globally. You can’t just remove a top three player” without creating a key constraint on the global economy, he said.
And with the Fed set to begin a cycle of rate increases in the next week or two, surging oil prices will be a “huge headwind to policy attempts on inflation,” he said.
In addition, Russia and Ukraine are both major exporters of fertilizers, he said, like ammonia and nitrogen, which will affect food production and contribute to higher food prices and, in turn, inflation.
“This is not just a military engagement,” said Dines. “It really is buyer beware. This is a really big historical event, and the cone of uncertainty is high. I don’t see this getting put back together very easily.”
