Market Commentary: Russia-Ukraine Tensions, Inflation Among Contributors to Market Volatility After Relatively Calm 2021

Market uncertainty on multiple fronts is making it tough for investors. Russia’s ambitions in Ukraine, inflation, and some upheaval in individual securities are making it more challenging to bear risk than last year. 2021 was relatively calm, with only 80% as many 1% daily moves in the market as normal, and many of those were upswings. Who doesn’t love a 1% jump?

Key Points for the Week

• Market volatility persisted, as heightened tensions with Russia added concerns to already rattled markets.
• U.S. retail sales rebounded after a December drop, posting a 3.8% spike, which was well above expectations. Inflation was only partially responsible as consumers spent heavily on goods.
• Online and auto sales were strong, with their January year-over-year numbers hitting 8.4% and 13.7%, respectively. Both categories are above their pre-crisis trends.

With all the angst about key issues, the economy remains relatively strong. Retail sales jumped 3.8% last month and were 3.1% higher after inflation. Consumers continue to spend, particularly online and for new cars. The retail data reflects the now-regular theme that when COVID cases rise, so do online sales and the demand for autos, which has likely been intensified by the chip shortage.

The pent-up demand for goods continues to contribute to higher prices at the producer level. Producer prices rose 1% last month, indicating pricing pressures remain strong and will likely get passed on to consumers for many goods. The expectation the Federal Reserve will increase interest rates and reduce its balance sheet has pushed mortgage rates to their highest levels since early 2019.

The S&P 500 declined 1.5% last week. The MSCI ACWI declined 1.7% as the fallout from any sanctions against or by Russia would likely hurt European economies more than the U.S. The Bloomberg U.S. Aggregate Bond Index shed another 0.2%, with losses concentrated in the corporate bond market. Russia’s intentions toward Ukraine and the possibility of a summit remain the biggest near-term risks to markets. The personal consumption price report will give additional insight into incomes, spending, and inflation.

Figure 1 (Date Through 2/17/22)

Why is the Market so Volatile?

Market volatility is on the rise. As Figure 1 shows, the S&P 500 has dropped more than 1% ten times already. Before jumping into the key reasons for the volatility, the chart shows this type of volatility isn’t unprecedented. Other years have seen high numbers of declines in the first two months of the year. Beyond January and February, the S&P had a pair of two-month periods in 2018 that saw 10 days of 1% declines. Early 2020 marked even higher volatility as COVID-19 entered our world.

The past volatility also reminds us corrections are a normal part of investing. Technically, the S&P 500 hasn’t even officially reached correction territory as it hasn’t closed down by more than 10% from its all-time record set earlier this year. Even if the market declines further this week, it really doesn’t change the historical fact that we should expect periods of volatility.

Downturns rarely happen for no reason, and understanding the reasons behind market movements can make it easier to be steadfast during periods of volatility. 2022 is off to a volatile start for three major reasons:

• Russia threatening Ukraine
• Inflation and interest rates
• Lower sales and earnings projections

Russia and Ukraine

Russians threatening Ukraine with invasion is a different kind of risk than inflation or earnings revisions. The range of outcomes is much wider, and the risks involve people’s lives, not the prices of used cars. The risk of a land war in Europe raises concerns about a large conflict involving multiple countries. It brings to mind World War I or the early aggression by Nazi Germany that preceded World War II.

For many this conflict seems new. It actually started in 2014, when Russians took territory from Ukraine. The ongoing conflict has costs 13,000 people their lives.

Our view is Russian aggression would likely lead to a market correction that would hurt Europe more than U.S. markets. Europe imports much of its energy from Russia. During the 2014 conflict, the MSCI Europe index fell 2.5%, but the U.S. market dropped only 0.7%. We would expect the short-term reaction to be larger than in 2014 if Russia launches a full invasion.

Inflation and Interest Rates

Closer to home is the uncertainty about how quickly the Federal Reserve will raise interest rates. Some investors are worried inflation won’t respond to slightly higher rates and the Fed will be forced to raise rates rapidly to snuff out inflation. Others see the Fed as raising rates too quickly and undercutting the recovery. The value of earnings drops when interest rates increase. Growth stocks, which have led the market during the last decade, generate more of their earnings in the future and are more sensitive to changes in interest rates. The Russell 1000 Growth is down 13.6% this year, while the Russell 1000 Value is only 3.8% lower.

Lower Sales and Earnings Projections

Difficult comparisons and lower expectations have also been a challenge to many stocks. The list of steep declines includes key names in social media, streaming, and online commerce. Some of these companies were big beneficiaries of the move online during the pandemic and the large economic support checks issued by the government. But competition and slowing growth have caused declines of more than 35% in multiple large companies.

The Key Risk

What makes this environment more challenging is the risks are heightened at every level. Geopolitical, economic, and individual company risks are always present. Today each seems at elevated levels. Russia’s potential invasion is a geopolitical uncertainty with widely unknown outcomes. High inflation and uncertainty around interest rate policy have created a wider set of economic outcomes than normal. Big swings in the future expectations for previous market winners have created big swings in some popular companies.

Yet, none of those risks is as important as the key risk, which is how investors react to challenges. All these types of risks ebb and flow. Sometimes they can be quite severe. Other times they produce swift market reactions. While these swings can set portfolios back, quite often the biggest damage comes from overreacting to risks and pulling out of the market.

Think about your portfolio like being on exercise equipment. If you get on a machine that is more challenging than you want today, it doesn’t mean you shouldn’t use the machine. Instead, just dial back the difficulty or lower the weight until it is at the right level. Long-term returns are the rewards for bearing the risk of being invested. If today’s markets are proving difficult, reach out to your advisor and see if dialing back the risk might make our portfolio’s workout a little easier to bear.

About Christina Hester Snyder

Christina is an associate partner and wealth advisor at Jacob William Advisory with a storied 20-plus year career in financial services. Christina is known for her commitment to her clients and is dedicated to helping them alleviate their financial fears through education and planning that goes far beyond investments. She believes in a comprehensive approach that addresses all facets of planning, including wealth transfer, insurance, taxes, investments, estate and trust planning, retirement, risk management, and business planning. Christina graduated from the University of Baltimore with a Bachelor of Science in Business with an emphasis in international business. She also holds many professional designations, including CERTIFIED FINANCIAL PLANNER™ (CFP®), Chartered Financial Consultant® (ChFC®), Retirement Income Certified Professional® (RIPC®), and Certified IRA Services Professional (CISP™). She is an active member of her community and is involved in many professional and nonprofit groups, including acting as the president of the Maryland chapter of Women in Insurance & Financial Services and serving on the board of a nonprofit that helps Maryland families with financial hardships. To learn more about Christina, please click here.

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