The Conflict and its Impact
The rocky start to 2022 for share markets continued into February. Following the market correction in January, due to inflationary pressures and rising political tensions, early February saw a high level of volatility in the U.S and European share markets, particularly as Russian troops massed on the Ukrainian border…. despite Russia repeatedly denying its intentions to invade.
A few days later, we saw the situation unfold into a full-scale war between the two countries, and so far, both sides seem to have suffered significant losses. The initial invasion sparked a three per cent fall on the S&P/ASX 200 and a 1.5 per cent drop on the S&P 500 index. Share markets more exposed to the Russian market, primarily Italy, Germany, and France fell further, with the Euro top 50 index ending the month 10% below its January high.
As the situation has developed, we have seen the horrors of people defending their homeland and reports of many civilian deaths in the bombings. Initial surprise quickly led to shock and anger. Many countries placed sanctions on Russian business and key government officials, with Australia, the UK, the U.S, and many European countries imposing travel restrictions and sanctions against many Russian banks. We have also seen several countries move to freeze and seize the assets of wealthy Russians with ties to the Kremlin.
The impact of these sanctions saw the Ruble crash in late February, dropping to less than USD1 cent, while the Russian stock market fell by over 30% before all trading halted on the 25th of February.
Despite the high level of volatility we have seen in share markets, the S&P/ASX 200 rose for February, providing 2.09 per cent on the back of gains in the energy and materials sectors. The index also remains optimistic for the 12-month period, with a 10.25 per cent return. Once again, technology stocks struggled, and we saw Value stocks outperform Growth stocks, a persistent trend over the past few months.
This positive return for Australian shares was somewhat of an anomaly across global markets, though, with the MSCI World (ex Australia) index dropping by 2.76 per cent for the month, as investors sought to assess the potential economic impact of the Russian sanctions. This fall in February represents the first two consecutive monthly drops in the index since October 2020. Like Australia, we saw Global Value outperform the wider market, with small companies doing the same. The Emerging markets sector underperformed as a result of the Russian exposure. Thankfully, the Capital Partners portfolios have a very small allocation to the Russian region.
In the bond market, we saw yields rise sharply at the beginning of the month, on the expectation of a tightening across the U.S and Europe with several rate hikes expected in the U.S. As a result of the growing tension, yields began to decline mid-month and fell further following the invasion. Despite this late fall, the Global Aggregate Bond Index ended lower, dropping by 1.30%.
It’s difficult not to be concerned in times such as this with the impact of conflicts such as this one being unknown. When we look at history, we can see that these geopolitical events follow a similar trend.
As detailed above, we typically see an initial reaction from the market, followed by a high level of volatility. Then markets begin to recover, absorbing the shock and exhibiting a high level of resilience in the face of geopolitical conflict, with the average recovery being just 47 days. This acts as a prudent reminder to investors to remain calm and stay invested.
While the thought of inflation has faded into the background for some due to the conflict taking the limelight, it does, however, remain an underlying issue, now exacerbated by the Russian/Ukrainian war pushing commodity prices, such as oil, higher. This will likely keep inflationary pressure high for the short term. However, we see this pressure as short-lived and believe that once the COVID driven supply-side issues wane, we will see inflation fall back to normal levels.
One of our favourite graphics, shown below, also serves as a helpful reminder that humans can always find a reason to be concerned about something. This global issue has the potential to derail financial markets temporarily. Yet every time, without exception, the problem is absorbed, and markets move on to new highs.
This is the nature of markets!