Globally, stocks sold-off as investors digested rising geopolitical tensions at a time of elevated inflation and tightening central banks. The MSCI All Country World index tumbled 1.7% while the S&P 500 dropped 1.6% and the NASDAQ slipped 1.8%. International stocks did not fare much better with European and Japanese stocks falling by 2.3% and 1.6%, respectively. The 10-year U.S. Treasury yield was little changed at 1.93%.
On February 21, Russian President Vladimir Putin signed decrees recognizing two regions in the east of Ukraine, Donetsk and Luhansk, as independent republics and ordered Russian troops into the regions. In response, the White House announced that President Biden would sign an executive order cutting off western financing. Forthcoming sanctions could also target Russia’s banking sector, restrict access to semiconductors, and target select Russian officials.
We see a military response from the North Atlantic Treaty Organization (NATO) as extremely low. Excluding the attack on Pearl Harbor, the average S&P 500 drawdown in response to geopolitical events has been 4.7%. On average, the market recovered those losses after about one month.
The Week in Review
U.S. retail sales unexpectedly jumped 3.8% in January. This was a sharp rebound after a 2.5% drop in December. Following the report, the Atlanta Fed’s GDPNow model revised up its first quarter 2021 GDP tracking estimate from 0.6% to 1.5%. The jump in sales reflected a notable rise in online sales and motor vehicle sales. However, we would caution against placing too much emphasis on the report because the large swings likely reflect significant seasonal adjustments. It also does not account for inflation. Real spending has fallen by an annualized rate of 6.8% between October 2021 and January 2022.
The Conference Board’s leading economic indicators index fell by 0.3% in January. The largest detractor was initial jobless claims for unemployment insurance, which subtracted 0.3 percentage points. The largest contributor continued to be the interest rate spread between the fed funds rate and the 10-year U.S. Treasury, which added 0.2 percentage points. While leading economic indicators have been moderating since peaking in April 2021, the index still suggests that the U.S. economy remains in expansion and the risk of a recession in the next 12 months remains low.
Geopolitical Risks Rise
On February 21, Russian President Vladimir Putin signed decrees recognizing two regions in the east of Ukraine, Donetsk and Luhansk, as independent republics and ordered Russian troops in the area to perform “peace-keeping duties.” President Putin also demanded that Ukraine must be demilitarized and give up its NATO ambitions. In response, the White House announced that President Biden would sign an executive order barring Americans from investing in, trading with or lending to these regions. German Chancellor Olaf Scholz stated that due to the Russian leader’s recognition of the breakaway republics, the Nord Stream 2 pipeline from Russia to Germany cannot go into operation. Forthcoming U.S. sanctions could target Russia’s banking sector, restrict access to semiconductors, and target select Russian officials. Importantly, the situation remains fluid with the U.S., European Union, UK, and China each likely mulling a response.
While further escalation seems likely, we see a military response from the North Atlantic Treaty Organization (NATO) as extremely low with President Biden already saying publicly that there is no scenario where he would send in American troops. Likewise, NATO Secretary General Jens Stoltenberg stated in 2021 that, “It is important to distinguish between NATO allies and partner Ukraine. NATO allies, there we provide Article 5 guarantees, collective defense guarantees, and we will defend and protect our allies. Ukraine is a partner, a highly-valued partner. There’s a difference between a partner Ukraine and an ally like, for instance, Latvia.” While signaling that NATO would not defend Ukraine, NATO did warn that Russia would pay a high price in terms of sanctions. With geopolitical tensions on the rise, it is not surprising that global equity markets have moved modestly lower, particularly Russia’s stock market (see figure 1). However, past geopolitical events suggest that the impact will likely not be long-lasting.
If we look back at historical returns around events like Pearl Harbor, 9/11, the Cuban Missile Crisis, etc. the average total drawdown was about 5.7% with the market bottoming after about 21 days and then taking about 51 days to recover. However, if the attack on Pearl Harbor is excluded, the market bottomed after just 13 days and fully recovered about a month later (see figure 2).
|Geopolitical Event||Event Date||S&P 500 Returns||Number of Days|
|One Day||Total Drawdown||Bottom||Recovery|
|U.S. Pulls Out of Afghanistan||8/30/2021||0.4%||-0.1%||1||3|
|Saudi Aramco Drone Strike||9/14/2019||-0.3%||-4.0%||19||41|
|North Korea Missile Crisis||7/28/2017||-0.1%||-1.5%||14||36|
|Bombing of Syria||4/7/2017||-0.1%||-1.2%||7||18|
|Boston Marathon Bombing||4/15/2013||-2.3%||-3.0%||4||15|
|London Subway Bombing||7/5/2005||0.9%||0.0%||1||4|
|U.S. Terrorist Attacks||9/11/2001||-4.9%||-11.6%||11||31|
|Iraq's Invasion of Kuwait||8/2/1990||-1.1%||-16.9%||71||189|
|Cuban Missile Crisis||10/16/1962||-0.3%||-6.6%||8||18|
|North Korea Invasion Of South Korea||6/25/1950||-5.4%||-12.9%||23||82|
|Pearl Harbor Attack||12/7/1941||-3.8%||-19.8%||143||307|
|Average:||-1.4%||-5.7%||average percent change for S&P 500 from hike to high across all given records in this table is 21.4||average percent change for number of months from hike to high across all given records in this table is 51.4|
|Average Excluding Pearl Harbor:||median percent change for S&P 500 from hike to high across all given records in this table is 12.7||median percent change for number of months from hike to high across all given records in this table is 33.1|
The impact on oil and other commodities (palladium, noble gases, wheat, aluminum, etc.) may be more pronounced with the price of Brent crude rising 3.7% since February 18 and approaching $100 per barrel (at the time of this writing the price is $97.01). It remains an open question as to how the rise in commodity prices may impact Federal Reserve policy. While the Fed may be worried that rising energy costs could weigh on economic activity, elevated levels of inflation may limit the Fed’s desire to react to the rising geopolitical risk. This is being reflected in financial markets with six rate hikes by the end of 2022 still being priced in. This limited desire to react may modestly increase the current level of economic risk when compared to Russia’s annexation of Crimea in 2014.
This backdrop of rising geopolitical tensions and monetary policy uncertainty is creating a volatile market environment. However, history suggests that these types of fluid events can change quickly and that trying to time the market is nearly impossible. History also suggests that there is little reason to try. Since 1990, simply staying invested would have netted an investor an average annual return of 10.8%. However, if an investor tried to time the market and missed the 20 best days, the average annual return drops to just 6.3% (see figure 3). We would also point out that 8 of the top 10 best days have occurred within just two weeks of the 10 worst days. Unfortunately, exiting positions as a result of volatility is usually a losing endeavor and typically weakens returns.
How to Allocate Assets in Evolving Markets
As we have previously highlighted, Citi’s Global Investment Committee (GIC) is maintaining its overweight in global equities but has moved in advance of these events by recommending upgrades to the quality of portfolios by shifting 10% into dividend growers and sectors like healthcare and consumer staples, which tend to hold up better during risk-off environments. We also added exposure to international stocks in Europe, Japan, and Switzerland where the rates of inflation are lower, central bank tightening is likely to be less, valuations are lower, and earnings growth is expected to improve throughout the year. We continue to see the U.S. economic expansion as enduring, but we recommend reducing exposure to the riskier parts of the global equity market and increasing exposure in regions that have fewer headwinds.
|Index||Weekly Chg (%)change in percent||YTD (%)year to date change in percent||12 Months (%)12 month change in percent||Div. Yield (%)division yield in percent|
|Instrument||Weekly Chgchange||YTDyear to date||12 Months12 month change||Level|
|10-Year Treasury Yield (%)||0 bps||41.8 bps||63 bps||1.93%|
|Index||Weekly Chg (%)change in percent||YTD (%)year to date in percent||12 Months12 month change||Div. Yield (%)division yield in percent|
The Week Ahead
|2/24||10:00||New Home Sales||JanJanuary||803k||811k|
|2/25||8:30||Durable Goods Orders||Jan PJanuary||1.0%||-0.7%|
|2/25||8:30||Cap Goods Orders Nondef Ex Air||Jan PJanuary||0.3%||0.3%|
|2/25||8:30||PCE Deflator YoY||JanJanuary||6.0%||5.8%|
|2/25||8:30||PCE Core Deflator YoY||JanJanuary||5.2%||4.9%|
|2/25||10:00||U. of Mich. Sentiment||Feb FFebruary||61.7||61.7|