Stock market volatility continues to intensify as Russia invades Ukraine. Oil markets, in particular, are feeling the crunch, with the price per barrel of Brent crude topping levels last seen in 2008. In the week ending March 5 alone, crude oil prices rose by 25% and have shown little signs of abating. Other commodities markets are also feeling an impact – grain prices recently hit a 14-year high, and aluminum prices have been on the rise. Russia is a key producer of all three. 1
The pressure being felt in commodities markets, combined with wall-to-wall coverage of the war, is no doubt weighing on investor sentiment and driving volatility inequities. Investors should brace for continued volatility in the coming weeks.
Bracing for volatility is largely a mental exercise, however, and is not the same thing as preparing your portfolio for a prolonged market downturn triggered by a global recession (neither of which I think is likely today). The United States economy is stronger today than most appreciate – consumer spending remains elevated, the labor market continues to add far more jobs than anticipated, and activity in the services and manufacturing sectors continues briskly in expansion mode. I do not think the war in Ukraine or higher oil prices will derail this expansion.
Even still, I understand many investors wonder if the current Russia situation is different. Is there a point where Russian escalation and spiraling energy prices turn the market bearish?
I have established in this space before that Russia’s economy and financial system are not interconnected and big enough to cause a global financial contagion, in my view. Russia makes up around 2% of the global economy, and its trade with the U.S. amounts to less than 1% of allof our imports and exports. Foreign exposure to Russian debt is also tiny – as of the end of 2021, about $20 billion of Russian debt was held by foreigners (largely in dollars and euros), and about $40 billion was denominated in rubles. Compared to the trillions of dollars that trade on a daily basis in global sovereign debt markets, this foreign exposure to Russian debt is simply not meaningful. The risk of a global financial shock is extremely low, in my view.
The risk in the energy markets is different, however, which is also why Western countries to date have avoided direct sanctions on Russian oil exports. Russian exports of crude and refined products accounted for about 7.5% of total global supply before the war, and a critical reality of the current energy market is that oil supplies are very tight. Removing a significant amount of Russian oil from global supply would drive already high prices even higher, which could ultimately impact consumer spending and economic growth.
My take on the issue is that Western sanctions on Russian oil are certainly not a bullish outcome, but they are also not automatically bearish. Oil markets are global, meaning that a decline in Russian supply could be addressed by shifting flows of oil from other parts of the world. Europe could buy more crude from the North Sea, Africa, and the Middle East, and the United States could ramp up production domestically (an activity that is already underway). The Russian flagship oil, known as Urals, is similar in makeup to the Arab Medium produced in Saudi Arabia and also the oil that flows from Iraq. Those countries could increase production to take advantage of higher prices and newfound demand.
To be fair though, shifting around oil supplies is a complex undertaking, requires more production from non-Russian countries, and will take time – all factors that would likely mean short-term pain if the export controls on Russian oil are enacted. I think some of last week’s market’s bumpiness is tied to the uncertainty over what the U.S. and Europe will ultimately decide – a factor to watch closely.
The other big risk I see today is the risk of the conflict shifting from regional to global. Russia has already taken the very brazen and hostile action of invading Ukraine unprovoked, and the desire to be seen as victorious – coupled with economic desperation – could cause Russia to escalate even further. The outcome is impossible to predict, but in my view, as long as a global conflict is avoided, a U.S. and global recession will be avoided too.
The Bottom Line for Investors
It is truly disheartening to follow the developments in Ukraine as this conflict unfolds. But investors need to find a way to set emotions aside when it comes to making investment decisions in the current environment. If your investment portfolio is well-diversified and allocated in line with your long-term goals, the appropriate response right now is to do nothing, in my view.
I know that’s hard. Watching coverage of the war and witnessing volatility in the markets can give all investors the urge to ‘do something,’ i.e., to make adjustments to your asset allocation in response to the uncertainty. But this urge will lead to errors. In the short run, the market’s ups and downs are normal and natural, even when there is a geopolitical conflict driving them. In the long run, enduring this volatility is the price investors pay for equity-like returns. It’s the cost of doing business.
Disclosure