- While the Russian invasion of Ukraine has unnerved financial markets and increased downside risks in the near term, we continue to believe the outlook for economic growth in the U.S. remains on solid footing.
- Market volatility will likely remain heightened as the situation develops and fighting continues in Ukraine, but the impact on U.S. economic growth should be limited unless financial conditions tighten significantly.
- Commodity price increases are the most direct risk, as rising prices of gasoline and other commodity-sensitive consumer goods reduces purchasing power for consumers and businesses. This could result in higher inflation that might linger further into the year than previously expected.
- As such, the Fed will likely stay the course and proceed with plans to raise rates and reduce its balance sheet unless conditions deteriorate significantly and negatively impact the growth outlook.
- Within our portfolios, we are not making any material adjustments to positioning. Financial markets and valuations have adjusted to these risks and uncertainties. We remain overweight credit risk within fixed income portfolios and overweight equities within our balanced portfolios.
In Ukraine, a worst case scenario is playing out with the Russian invasion. Vladimir Putin’s intended outcome and end goals are uncertain at this point, but best indications are that Russia is seeking to knock out Ukrainian military capabilities and potentially set up a friendly regime in Kyiv (Putin has declared this to be the goal, and actions on ground support this). The full scale of Western response to Russian aggression is not yet available, but tighter sanction packages are being implemented by a host of nations.
Fixed Income Viewpoint
The Fort Washington fixed income team has not made any material portfolio changes in response to the conflict. Changes could occur if valuations would adjust to levels that provide for more compelling risk/adjusted returns, and the team would look to add risk in that environment, barring any material deterioration in our economic outlook.A few fixed income strategies do have modest Ukraine exposure through holdings in sovereigns, quasi-sovereigns, and corporates, but the impact to overall performance should be limited. At current levels and exposure, we continue to hold these securities. If/when hostilities cease, potential outcomes range from preservation of the existing Ukrainian government to a Russian installed regime or Russian occupation, or something in-between. Risks are significant especially relating to potential for prolonged conflict, damage caused by conflict, and potential sanctions in the case of Russian success.
Equity Viewpoint
The path of the U.S. equity market will ultimately be decided by valuations and earnings of U.S. stocks. We believe there will be some impact on economic growth/earnings, which were already a bit more uncertain due to inflation/monetary tightening. The current conflict likely won’t impact the path of the Fed, resulting in continued reduction of accommodative policy and higher real interest rates, pressuring equity valuations. As for earnings, we believe the direct impact from conflict will be muted. Russia and Ukraine combine for roughly 1% of revenue for the S&P 500 Index—an immaterial amount that will not affect earnings. Rather, earnings could be pressured if global growth slows as a result of conflict, and/or inflation is more persistent due to persistently higher oil prices.
How May the Conflict Impact Energy Markets?
Our view is that oil markets could experience tremendous volatility as major players in the market have the potential to add, remove, or restrict the free flow of barrels to consumers. Right now, there is no clear directional read for the commodity. Demand is strong, but fear and uncertainty are driving prices (up and down). Based on comments from Western nations, it appears unlikely at this time that Russian energy companies will be sanctioned. U.S. exposed oil producers and midstream operators are well positioned to increase oil production (and gas processing) if prices continue to move higher, while the balance sheets have firmed up sufficiently that they ought to be able to handle downward pressure from the commodity. While current dynamics support higher oil prices, downward pressure on prices could also come from a SPR (Strategic Petroleum Reserve) release, Iran nuclear deal, and increased production.
Conclusion
Market volatility will likely remain heightened as the situation develops and fighting continues, but the impact on U.S. economic growth should be limited unless financial conditions tighten significantly. Europe remains most exposed to the conflict between Russia and Ukraine given already tight energy supply and heavy reliance on Russian natural gas imports.
Past performance is not indicative of future results. This publication contains the current opinions of Fort Washington Investment Advisors, Inc. Such opinions are subject to change without notice. This publication has been distributed for informational purposes only and should not be considered as investment advice or a recommendation of any particular security, strategy, or investment product. Information and statistics contained herein have been obtained from sources believed to be reliable and are accurate to the best of our knowledge. No part of this publication may be reproduced in any form, or referred to in any other publication, without express written permission of Fort Washington Investment Advisors, Inc.
