Russia vs. Ukraine: What a Mess.

Russia’s invasion of Ukraine this morning has made a somewhat murky geopolitical picture even more so. What does this conflict mean for global investors, US citizens, and their pocketbooks? While that might seem cold given the present situation, it is what many, if not most, people would like to know.

Oakworth Capital Bank’s Investment Committee has been assessing the turmoil as it has unfolded. During tense circumstances, it can be difficult to take ‘a step back’ and view things without emotion. However, it is imperative to do so.

Despite this morning’s news, the following bullet points are our opinion(s) of the current state of the US economy. Ultimately, that is the most important thing for US investors to consider.

  • US labor markets remains strong, with the official Unemployment Rate currently at 4.0%.
  • Consumer confidence remains firm, with most sentiment gauges above their 20-year averages.
  • Business owner sentiment remains solid.
  • Interest rates are low in both absolute and relative terms.
  • Domestic manufacturing continues to expand.
  • PMI surveys (Markit and ISM) suggest solid expansion.
  • The financial markets are flush with liquidity, and bank balance sheets are strong.
  • US stock valuations are much more attractive now than they were at the start of the year.
  • The yield curve remains positively sloped, which supports the extension of credit.
  • US household balance sheets are in extremely healthy condition, as US household wealth has increased roughly $20 trillion over the last 2 years.
  • Inflation appears to be elevated due more to a supply demand mismatch than monetary policy.
  • New COVID-19 cases have been falling dramatically.
  • Corporate earnings announcements continue to meet or exceed analysts’ expectations.
  • The economy grew at a vigorous 7% clip in Q4.

Essentially, BUT FOR Russian shenanigans in eastern Ukraine, all signs would point to continued economic growth and higher stock prices. With that said, we have been candid in telling people: “the returns won’t be quite as easy or as robust as they have been the preceding 3 years.” However, you can’t discount a major war in Europe…if it does, in fact, morph into a major war.

Fortunately, or unfortunately if you are Ukrainian, there doesn’t appear to be much appetite in Washington, London, Berlin, Paris, or Rome to get into a ‘hot war’ with Moscow because of recent events. It is important to note Ukraine is NOT an official member of NATO. As such, the US is not under a treaty obligation to protect Kiev from Russian aggression. For their part, the European powers aren’t prepared to face Putin’s much improved military without assistance from the Americans.

In the financial services industry, we are supposed to say “past performance is not indicative of future results.” However, as we all know “those that don’t learn from history are doomed to repeat it” and the past is the past predictor of the future. Why is this important?

Lost in the wringing of hands and gnashing of teeth over the current state of affairs is the relatively recent history of the Russian annexation of Crimea. In case you forgot, this happened at roughly this time (2/20-3/26) in 2014, and how did the markets ultimately respond? Yawns or crickets would be appropriate answers.

Despite international condemnations, resolutions, and economic sanctions, Moscow retook what had been part of greater Russia for centuries, and no one did much of anything about it. To that end, the S&P 500 Index stood at 1,828.75 on 2/19/2014, and closed at 1,852.56 on 3/26/2014. That’s right, it went up. Further, generic crude oil futures (WTI) actually went down over this time frame.

The reasons for this appear to be somewhat self-evident. While the world has to respond, in some form or fashion, to Russian expansionism, a quick look at a map and brief skim of a history book will give valuable insight as to Moscow’s intentions. Further, and truthfully, Ukraine is not an economically important country to the primary western powers. It is one of the more corrupt and repressive countries in Europe, and remains one of the least successful of the former Soviet republics in Europe. Where the rubber meets the road, and somewhat coldly, Ukrainian independence is of very little economic importance to people outside of Ukraine.

As a result, it is extremely difficult to imagine much more of a ‘coordinated’ response from the NATO powers other than economic sanctions and the freezing of some targeted financial assets. This will have a relatively limited effect, as Russia will simply be able to turn its sights east, to China, for access to markets and capital.

Also, and very importantly as I write this on 2/24/2022, India appears ready and willing to stay on the proverbial sidelines. This isn’t all that surprising given that country’s history of being a leader in the Non-Aligned Movement. This is important, as India and China, combined, comprise roughly 37% of global Gross Domestic Product, (GDP) when adjusted for purchasing power parity (PPP).

Even so, there is significant concern this conflict will have a negative impact on inflation, namely energy prices. While this could happen in the short-term, this likely won’t be much more than a transitory issue, largely for the reason implied in the previous paragraph. As long as there is an external market for Russian energy, it will find its way, either directly or indirectly, into the global markets and supply.

For instance, China can shift demand for crude oil imports from the Middle East and Africa to Russia. When that happens, that will mean there is more energy available from those areas for Europe, etc. Of course, there will be a period of price discovery and changing logistics. However, ultimately, global supply is global supply, and the relationship between global supply and global demand sets, drum roll please, global prices.

This, then, takes us back to the original question: what does this conflict mean for global investors, US citizens, and their pocketbooks? The probable case scenario is, after a few days of angst, probably not much. Thanks to China, Moscow will still have at least indirect access to the global markets, and Ukraine’s economic output is equal to roughly 0.29% of global GDP. That is the stone cold truth. Unless the US, and it would be the US to make such a decision, decides to get into a shooting war with Russia over Ukraine, from purely an economic standpoint, this will be just a bump in road to growth.

Of far greater importance is how aggressive the US Federal Reserve will be when, or if, it embarks on its highly anticipated ‘tightening cycle’ at the upcoming FOMC meeting on March 16th. As I type, the markets apparently don’t think this particular turmoil is going to keep the Fed from doing what the Fed wants to do. To that end, on 2/17/2022 the implied overnight rate in the futures market for 02/01/23 was 1.671%. Today, it is, drum roll please, 1.674%. For grins, last week, the implied year-end (12/31/22) was 1.585%, and today it is 1.578%.

Trust me, the health of the US economy has much more to do with the price of money in its financial system than it does just about anything else. As for inflation expectations, well, last week 1-year inflation expectations hovered around 4.1%. Today, they are 4.6%. While higher, that isn’t quite the extreme level, or death knell scenario, many had been fearing.

Therefore, for all intents and purposes, the markets don’t believe this is or should be a long-term issue. If so, today’s trading is more emotional than rational. As we all well know, people tend to make bad decisions when they are emotional.

In the end, while we certainly don’t like what is happening in eastern Ukraine, now is not the time for investors to panic. Frankly, the more stocks fall, the more attractive they become. Further, we remain on path to continue to make trades throughout the year that best reflect the economic and financial conditions, and avoid chasing rabbits down holes, taking worst case scenarios to their illogical conclusions, and sliding down slippery slopes with the masses.

Thank you for your continued support. As always, I hope this newsletter finds you and your family well; may your blessings outweigh your sorrows not only on this day but on every day, and may the conflict and bloodshed in Ukraine end quickly.

John Norris
John Norris
Chief Economist


Please note, nothing in this newsletter should be considered or otherwise construed as an offer to buy or sell investment services or securities of any type. Any individual action you might take from reading this newsletter is at your own risk. My opinion, as those of our investment committee, is subject to change without notice. Finally, the opinions expressed herein are not necessarily those of the rest of the associates and/or shareholders of Oakworth Capital Bank or the official position of the company itself.