Key Points:
- “A hawkish tilt in major central-bank rhetoric, mixed global macroeconomic data underscored by persistent inflation, and geopolitical uncertainty surrounding the Russia-NATO conflict marked a volatile start of the year.” – Wellington Management.
- Energy stocks were the only positive sector of the S&P500, gaining over 7% as oil spiked to $100/bbl.
- The situation in Ukraine will impact markets for the foreseeable future, but the US economy (aside from high inflation readings) appears to be in relatively good shape.
Risk assets took a hit in February in the wake of the Russian invasion of Ukraine. As tensions continue to escalate, the economic impact of higher energy prices weighed on equity markets in February. The S&P500 dropped 2.99% for the month, bringing its year-to-date loss to -8.01%. Small cap stocks, whose revenues tend to be more domestically oriented, were positive in February with the Russell 2000 up 1.07%. Value stocks continued to outpace growth stocks with energy being the only major sector to post a positive return (+7.13%). The communications services sector saw the largest loss in the S&P500, down 6.98% with shares of Meta (Facebook) losing nearly a third of its value. Energy stocks have gained 27.59% year to date, with oil and natural gas prices at multi-year highs. The conflict in Ukraine has sent European natural gas prices up over 60% and global crude oil above $100. Higher energy prices are weighing on the outlook for the global economic recovery pushing inflation expectations higher. Higher energy prices, when inflation is already running hot, have investors worried about stagflation: a period where of higher-than-average inflation with little to no economic growth.
The Federal Reserve is expected to raise the Federal Funds rate at their next meeting in an effort to slow inflation. The market expects anywhere between four and seven 25 basis point rate hikes this year. The Fed finds itself in a difficult situation where they need to raise rates to slow inflation but not too quickly so as to choke off economic growth. Bond yields were also rather volatile during February, as inflation fears pushed the 10-year Treasury yield above 2%, but then fell swiftly after the Russian invasion began. Higher demand for safe haven Treasury bonds pushed yields back down but the Bloomberg Aggregate Bond Index still lost 1.12% on higher rates for the month.
Cutting off Russian exports to the world to curtail further invasions will most certainly be inflationary. Russia is a major energy exporter to Europe, as well as a global commodities supplier: fertilizer, wheat, aluminum, palladium etc. The uncertainty of how this plays out will weigh on market sentiment for the duration of the Russian occupation of Ukraine (which could be weeks or months). Fortunately, the US economy came into this situation in relatively good shape: US GDP in the fourth quarter of 2021 was 7%, the unemployment rate fell to 4% and the impact of COVID wanes by the day. Markets will continue to be choppy for short-term traders. Long-term investors should continue to remain diversified.
Sources: Morningstar Direct, JPMorgan, Wellington, Wall Street Journal.
Indices mentioned are unmanaged and cannot be invested into directly.