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What I Care About This Week | 2022 Jan 31

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by Franklin J. Parker, CFA

The Summary

The Details

The Wall Street Journal reported today that Ukraine-Russia tensions have pushed up wheat prices (though it does appear the upward trend began years ago). I have been talking about my concern for increased tensions for the past few months. But, how concerned should investors be from the perspective of their portfolios?

First and most important: markets do not like uncertainty. War (or a regional conflict) is among the most uncertain things that markets can experience. In general, then, the potential for hostile actions simply adds to volatility and will tend to depress prices.

That said, it appears unlikely that the US and her allies would risk an open war with a nuclear-armed Russia. It has been the policy of the United States to avoid open wars with nuclear states at all costs. Though I must admit my non-expertise in this area, I see a US war with Russia as a very low-probability scenario.

Even if the US and her allies are not involved, hostilities still disrupt the lives of millions of people, cut off trade routes, and disrupt production in the areas around the conflict. This is obviously bad for economic activity.

Furthermore, the US and her allies have indicated they would impose crippling sanctions on Russian oligarchs as well as Russia herself. While US trade with Russia is relatively insignificant (Russia is the US’s 26th largest trading partner with about $35 billion in goods traded per year), Russian trade with the European Union is much more significant. Russia is the EU’s 5th largest trading partner (and the EU is Russia’s largest trading partner). More importantly, Russia supplies over a third of the natural gas used by the EU.

In other words, sanctions, though painful to Russia, are also painful to Europe. Europe is already struggling with economic growth and inflation, and sanctions are sure to exacerbate those problems. This regional conflict, then, could be the straw that breaks the camel’s back, pushing Europe into a recession.

Chart of the Week

Market volatility is back! Although, much of what we have seen is normal, we just forgot because the Federal Reserve has been pulling volatility from markets for the past decade. The recent bounce in markets has led some to question whether the selloff is over. While it is very, very hard to predict these things, my view is that we have a bit more downside to go.

In the chart below, I have plotted my baseline case for the S&P 500. I expect March/April to be the bottom, and I expect the S&P 500 to be down 15% to 20% at the bottom. It is not uncommon to see a bounce after hitting an important milestone (down 10%), but there is still significant overhead resistance for markets around the 4500 level. Unless markets push above that level with some conviction, I do not believe the recent bounce has escape velocity.

Again, short-term swings are notoriously hard to predict, so I may well update my view as new data and market action comes in.

S&P 500 Index, Current and Outlook

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