Historical perspective is sometimes a useful way to get through market challenges, even though history is not a predictor of what is to come. We started 2022 off worrying about Omicron, then shifted that burden of concern to the prospect of aggressive central bank tightening and a bond market sell-off. Now, after only six weeks into the year, we are dealing with yet another spectre and one that few had on their list of risks – a possible invasion of Ukraine by Russia.

 

The amassing of Russian troops, equipment and support on the border has been in the news for weeks now and nothing has happened. Still, the anticipation of an invasion and its consequences have swayed the market like a floaty at the Great Wolf Lodge wave pool.  Negative rhetoric sends the market into a nose-dive, like Thursday’s comments from White House warnings of an “imminent attack”. Then we have days where a couple of words sends the markets higher, like when Vladimir Putin said “all right” to a suggestion from Russia’s foreign minister that they continue diplomatic efforts. At the time of writing, said foreign minister and the US Secretary of State announced they will continue talks next week.

 

This may turn out to be one big game of chess, where nothing materially happens, but markets are clearly not betting big on that. Even with a modest bounce this morning, the S&P500 is still down close to 8% since the start of the year. This decline is similar, at least in the runup to a potential conflict, to where we were this time in February 2014 when Russia entered Crimea and ended up annexing the Ukrainian region. This also happened during the middle of a Democrat administration (Obama’s second term), and it came after a year where stocks rallied strongly. Interestingly enough, this was also a time when we had just come through the infamous 2013 Fed “taper tantrum”, which saw bonds correct sharply during that year.

 

 

In 2013, the S&P500 had rallied by just over 29%, despite the slip in bonds and (misplaced) fears that the Fed was going to pull the punch bowl away from the party too soon. It was also a rough start to 2014, like this year. The S&P fell 5.7% by the start of February, mainly on concerns that Chinese economic activity was slipping.  As you can see from the chart, the initial meltdown in stocks in January was almost all Fed fear. What has happened in the past week or so is mainly Russia-Ukraine.

 

What didn’t happen in 2014 is any material impact from Russia’s invasion into Crimea. In fact, from February 23^rd (when Putin announced it was time to return Crimea to Russian control) to March 21^st (when the Republic of Crimea became a federal subject of Russia), the S&P had actually advanced 2%. This is not to say that nerves were frayed during this period, and US stocks came out pretty unscathed. The German DAX index fell more than 5% over the same period and was down better than 7% at its worst level on March 13^th.  

 

Russia’s stock market was hit even harder, as the benchmark MICEX index fell 18% over the space of four weeks. The Russian economy was already fading going into the conflict, with year-over-year growth in real GDP falling from a peak above 5% in 2012 to about 1% in 2013. The combination of sanctions and falling oil prices took the country into recession the following year.

 

Crude oil, which initially benefited from the geopolitical tension and rallied to north of $104/barrel, ultimately lost about 3% over the affair. Similar to 2014, crude oil futures have advanced strongly since the beginning of December and are up about $30/barrel. Not quite $100 oil, though an actual conflict would likely take us through that level. Next week I will delve into the 2014 oil comparison a little deeper and how the $100 experience came to an abrupt end after the middle of the year.

 

 

Yet here we are again – analyzing an outcome that has only probability and not certainty. The major difference between 2014 and today is clearly scale. Not to diminish the socioeconomic impact from that annexation, but the Crimean incursion was a nibble compared to a main course like Ukraine. This is also the reason why there have been such large swings in the market as we progress through the political banter. In 2014, this was Russia flexing muscles in front of an Echelon screen, while today it is going hard on the squat rack in the gym in front of everyone. It might go for a personal best or it might go back to the changeroom. We can speculate, but we don’t know.

 

What we do know is the range of outcomes is much larger this time around. We are also dealing with exogenous factors to the issue in Ukraine, like monetary policy transition and the trajectory of economic growth. In less than a month from now, the Fed will hold probably the most important and anticipated FOMC meeting in many years. Despite the fact that geopolitical tensions are adding to business and investor uncertainty and nervousness, Fed officials appear on course for at least a quarter-point rate hike in March.

 

At the same time, economic indicators are suggesting underlying growth is starting to fade. US housing starts fell 4.1% in January, compared to forecasts for basically a flat month. The Philly Fed index for February also came in a little light at 16 (versus consensus of 20), and initial jobless claims in the US rose to 248,000 from a revised 225,000 in the prior week. Earlier in the week, we saw the Empire State manufacturing index come in much weaker than expected.  On Wednesday’s conference call (playback details can be found at the end of the newsletter), I remarked how US retail sales were strong in January, but the rising rate environment suggests a tailing off.

 

 

Suffice to say, we are transitioning into a different economy. Not necessarily a bad economy, but definitely one where the headwinds are blowing harder than the tailwinds. We saw something similar in 2014 as well – a year where Russian actually went through with something and when weaker demand / increased supply led to a precipitous decline in oil prices. Still, the stock market managed to get through it, with the S&P500 advancing about 11% on the year and TSX rising just over 7%. It was a rollercoaster ride, but that is why we have asset allocation strategies – to enhance risk-adjusted return, instead of just shooting for return.

 

On behalf of the Pyle Group, have a wonderful Family Day weekend.

Andrew

 

February 16^th conference call playback details:

 

CIBC Private Wealth consists of services provided by CIBC and certain of its subsidiaries, including CIBC Wood Gundy, a division of CIBC World Markets Inc.

The CIBC logo and “CIBC Private Wealth” are registered trademarks of CIBC, used under license. “Wood Gundy” is a registered trademark of CIBC World Markets Inc.

This information, including any opinion, is based on various sources believed to be reliable, but its accuracy cannot be guaranteed and is subject to change. CIBC and CIBC World Markets Inc., their affiliates, directors, officers and employees may buy, sell, or hold a position in securities of a company mentioned herein, its affiliates or subsidiaries, and may also perform financial advisory services, investment banking or other services for, or have lending or other credit relationships with the same.

CIBC World Markets Inc. and its representatives will receive sales commissions and/or a spread between bid and ask prices if you purchase, sell or hold the securities referred to above. © CIBC World Markets Inc. 2022.BC Wood Gundy, a division of CIBC World Markets Inc. “CIBC Private Wealth” is a registered trademark of CIBC, used under license.

Clients are advised to seek advice regarding their particular circumstances from their personal tax and legal advisors.

If you are currently a CIBC Wood Gundy client, please contact your Investment Advisor.