Russia invades Ukraine: what's next for the markets?

European stocks are bearing the brunt of the declines, falling 4% to 5% across the board. The S&P 500 Index was down nearly 2% in early trading, while U.S. Treasuries are catching a safe-haven rally, with 10-year yields down slightly to around 1.92%; the U.S. dollar is also seeing gains in a bid for safety. Oil prices were up more than 7% and nearing $100/barrel on Russia supply risks. Financial stocks are bearing the brunt of the pain in both the United States and Europe, given the global systematic risks and potential for defaults.

Historically, geopolitical events have tended not to leave long-lasting impressions on the global economy or on stocks. The two worst such events for markets since WWII have been Iraq’s invasion of Kuwait in 1990 (which led to a correction of 17% on the S&P 500 Index) and 9/11 in 2001 (a 12% correction).¹ But it’s important to note that what was happening in the economy and the markets beforehand may have had a larger impact. Leading up to 1990, the U.S. Federal Reserve (Fed) had been raising interest rates to slow the economy, then oil prices nearly doubled during the Middle East conflict, and the year ended with a four-month recession. As for the 9/11 terrorist attacks, the market was already contracting after the tech bubble and a recession had already begun in April 2001.

As of now, the S&P 500 Index drawdown (the peak to trough decline since January 3) is about 12%. While the negative price action is significant, we see a global economy that remains strong enough to withstand the conflict and a corporate earnings backdrop that remains supportive of stocks. Ultimately, market performance this year will likely still hinge on the Fed and how aggressive it becomes. Higher oil and commodity prices from the conflict are certainly not helping the inflation situation and may pose a risk to the economic/market cycle, depending on the Fed’s next steps. Since higher oil prices risk slowing the economy—or even creating stagflation—the Fed may opt for a slower pace of rate hikes. In our view, the worst-case scenario of seven or eight Fed rate hikes in 2022 is likely now off the table. This slower trajectory is now reflected in the yield on 2-year U.S. Treasuries, down around 7 basis points (bps) this morning to 1.52%. The yield curve continues to flatten and the 10/2 spread is now just over 40bps.

The bottom line is that we’re not making any changes to our views based on these developments. While the unfolding Russia/Ukraine crisis is likely to create significant volatility in the short term, ultimately the volatility may result in an opportunity to add to higher-quality positions in both stocks and bonds, particularly in the United States. Lower starting valuations in stocks and higher starting yields on bonds today could prove to be beneficial entry points for longer-term investors.

1 FactSet, as of February 24, 2022.