Geopolitical Risk is a Part of Investing in Global Markets
Geopolitical risk is a part of investing in global markets, and geopolitical-led market shifts are nearly impossible to predict. Russia's invasion into Ukraine was worse than many politicians and economists expected. It triggered a European security crisis and resulted in stricter sanctions than anticipated, and layered more volatility onto an already tense global financial market.
As a result of these new geopolitical risks being priced into the market, the S&P 500 has now entered correction territory, having traded down more than 10% from its highs. However, corrections are a normal part of investing. In fact, between 2008 and 2021 the S&P 500 corrected five times. According to investment research firm CFRA, the time between corrections in the S&P 500 is 410 days, on average. Prior to this year's recent decline in the S&P 500, the market had gone nearly two years without a correction.
In my last quarterly letter, I pointed to inflation as the second most pressing concern facing the market, behind COVID. With COVID cases down meaningfully since the beginning of the year, inflation remains at the forefront of most investors' minds. The Russia/Ukraine conflict is of particular concern, as it could immediately worsen the inflation picture, particularly as oil and natural gas prices continue to see upward pressure. Brent crude is up over 12% so far this week, and has traded above $100 per barrel.
However, based on recent UBS estimates, even if Brent prices were to remain elevated at $125/bbl for a period of around six months, U.S. economic output would be reduced by only 0.5%, suggesting a very low probability that higher fuel prices could trigger a recession. Furthermore, yesterday President Joe Biden said the U.S. (and potentially its allies) could release more strategic oil reserves which could ease pricing pressure.
Meanwhile, economic fundamentals remain strong. According to recent data from LPL Financial, 4Q21 S&P 500 earnings per share are tracking to a 31% year-over-year increase, about 10% above the consensus estimate when earnings season began. Consumer spending data released this morning also exceeded expectations, and showed that in the U.S., purchases of goods and services increased by the most in 10 months in January. Importantly, in the U.S. consumer spending accounts for roughly two thirds of economic output.
Market drawdowns resulting from geopolitical events typically don’t last long. Bill Stone, CIO of Glenview Trust, looked at 29 different geopolitical crises starting with WWII. He found that on average, stocks were higher three months after a geopolitical shock, and following 66% of events, they were higher after only one month.
Nearly all of our clients at Evolve Investing are long-term investors, who have the advantage of being able to look past short-term volatility. Over the last several months, I've had many conversations with my clients to ensure that asset allocations reflect each investor's risk tolerance, cash needs, and long-term goals. In some cases, we've increased risk by buying more stocks in high-quality companies, to take advantage of more attractive valuations. And in all cases, I recommend that we stay calm, patient, and diversified.