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A Message From Peter Mallouk: Russia, Ukraine and the Markets

February 24, 2022

After months of military build-up on the Ukrainian border, Russia has now moved into the eastern part of the country.

Some are speculating this may quickly become the biggest land war in Europe since World War II. First, an abbreviated review of modern history.

Russian President Vladimir Putin has stated publicly, many times, that he sees Ukraine as part of Russia. While Ukrainians may have felt this way long ago, in 2013 they made it clear that their hearts and minds had changed. Protests against Russia became louder and more impactful, as Ukrainians saw an alliance with the West as more hopeful for their future and sought a stronger alliance with western Europe. Ukrainians pushed their Russia-friendly president out of office, seeking leadership that would strengthen ties with western Europe. In 2014, Russia invaded and annexed Crimea, and the ensuing war claimed approximately 14,000 lives prior to a 2015 cease-fire.

For another relevant angle, we need to look at the history of the North Atlantic Treaty Organization, or NATO, which began forming after World War II. Today, NATO members are the United States and 29 other countries, including 27 in Europe. The NATO arrangement is pretty simple and can be summed up as, “If you attack one of us, you have to deal with all of us.” Over the years, more and more nations have joined NATO, most recently in eastern Europe, on Russia’s doorstep.

Over the past 10 years, there has been talk of Ukraine joining NATO, but nothing materialized. Russia has stated repeatedly that they view Ukraine joining NATO as an “existential threat,” much like Americans might perceive Canada joining a Russian military alliance. President Biden has made it clear – repeatedly and recently – that while there are no current plans to admit Ukraine into NATO, the United States will not commit to its future exclusion.

Politicians and pundits debate the reasons for the Russian incursion. Is Russia concerned about Ukraine’s emerging love affair with the West? Is it the threat of Ukraine joining NATO? Is it that Russia perceives the U.S. as weak coming off a prolonged war in Afghanistan? Is it simply that Russia is annexing parts of Ukraine that are already largely controlled by Russian-leaning forces? Or is Russia acting out of a position of weakness? It’s likely a combination of many of these, to varying degrees. What is clear is Russia’s influence and security have diminished tremendously over the last 30 years, and that, and least so far, the annexed territories – at least much of them – lean heavily towards Russia.

What will the United States or Europe, or anyone for that matter, do about this? Well, we can be quite sure (though not certain) that World War III is not likely to break out. How do we know how the U.S. will respond? Because President Biden told us. He has repeatedly made it clear that the U.S. would not respond militarily. Instead, President Biden has stated that the U.S. and other countries will respond with severe sanctions.

What happens from here? We could see everything from a swift diplomatic resolution, to a formal annexing of Russian-leaning parts of eastern Ukraine (likely), to a prolonged Russian occupation of larger parts of eastern Ukraine, to an escalation that can start on purpose or, as often is the case with war, by mistake. Thankfully, nearly all familiar with the history expect the conflict to remain relatively regionally contained, as every party involved loses in a wider conflict.

So, what happens to the investment landscape under the most likely scenario that involves an occupation or regional war?

First, we can expect energy prices to soar. Russia is a key energy producer and, as they face steep sanctions, we can expect energy supplies to contract while demand remains high. Energy prices are already higher than normal due to a global surge in demand coupled with supply chain issues. A prolonged crisis can create a spike upwards (even from these elevated levels) of not just oil companies, but clean energy companies as well, as demand for all types of energy needs to be met. A diversified investor has significant exposure to energy in their portfolio, and would see a lift from these investments.

But what about the rest of the diversified investor’s portfolio? Generally speaking, we would expect some weakness across a diversified portfolio, as markets price in a chance that the conflict could spread. If the market expects a potential global war, as it did after 9/11, it adjusts accordingly (by dropping a lot). If it expects things to remain relatively under control, it will soften a bit and adjust as new information unfolds.

What does history tell us?

The history paints a clear picture. The market prices in potential downside, but then does what it always does: recovers and moves on, and often it does so relatively quickly. The chart below illustrates how the market has reacted to various military conflicts and terrorist events and how long it took to recover.

Now, while the news likes to focus on one main issue and its impact on the market, the reality is there was a lot going on in the markets before Russia invaded Ukraine, and there is still a lot going on. From rising interest rates to high inflation, to near-record low unemployment, the markets are absorbing large amounts of information every minute of every hour of every day.

In the end, the stock market only cares about one thing: the future earnings of companies.

The market will look at this crisis and ask itself if companies like McDonald’s, Apple, Nike and Google are likely to make more money a few years from now than they do today. If the answer is yes, the markets will work themselves out.

Standing alone, this military event is not likely to make a long-term difference to the disciplined investor. Under some scenarios, there may be opportunities that present themselves, or the market may just move on and focus on other things. Either way, we will be monitoring carefully, and the Creative Planning team will be here for you.

Postscript: The bigger issue – for the markets and the world – is China, who, with its eye on Taiwan, is watching very carefully. But that’s a topic for another day, one hopefully not in the near future.

* All indexes are unmanaged and cannot be invested into directly. Past performance is no guarantee of future results. The modern design of the S&P 500 Index was first launched in 1957. Performance before then incorporates the performance of its predecessor index, the S&P 90.

This commentary is provided for general information purposes only, should not be construed as investment, tax or legal advice, and does not constitute an attorney/client relationship. Past performance of any market results is no assurance of future performance. The information contained herein has been obtained from sources deemed reliable but is not guaranteed.

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