Ukraine, Market Volatility, and Second Quarter Outlook

What is unfolding in Ukraine is extremely troubling. .The human toll of this humanitarian crisis is high and cannot be discounted. We believe, however, that it is our job to focus on the impact this crisis has on global markets and set aside our emotions in the commentary. Our hearts go out to those impacted by this war, including those here at home with loved ones in Ukraine, you are in our thoughts and prayers. We hope the war ends soon. As Russia presses its military advantage, it is inspiring to see Ukrainians defending their country. And while the images of fleeing refugees and bombed-out maternity wards create strong emotions, as your financial advisor, we’re here to help you keep those emotions in check as it relates to your financial planning.

Markets were volatile prior to the invasion and have become even more so over the past few weeks.  As we monitor the situation closely, nobody can predict market moves. We’ve seen broad selloffs followed by huge rallies – sometimes within the same trading session!

We see 3 major themes for 2022.

1.  Continued Volatility 
2. The Fed attempting to tame inflation
3. More Attractive Valuations

Volatility

We can see from this chart volatility did pick up in the first quarter. The average daily trading range had averaged around 1% last year and so far this year it has been double that. You can see it wasn’t quite as volatile as the first quarter of 2020, it has picked up a lot. Volatility will most likely continue, at least for the short term, as investors weigh the impact of rising inflation, energy prices, supply-chain disruptions, and interest rates. Signs of escalation or de-escalation in Ukraine will continue to move the indices.

Part of this volatility is related to inflation, which is running red hot right now. The consumer price index or CPI was 7.9% in February.  This is a 40-year high.

Inflation 

The inflation has a lot to do with the Ukraine war and subsequent sanctions which impacted energy prices and particularly oil prices.  High oil prices impact more than just driving to work. Goods are shipped and become more expensive, so high gas prices impact the majority of things we buy, including food. We hope that this inflation shock is temporary as other oil-producing countries make up for the lost Russian production.  However, there are other things causing inflation. Wage inflation is not as temporary, and we are seeing a tight labor market where employers have to compete for labor.  

Companies offered signing bonuses to restaurant workers and other service industries to compete. When extended unemployment benefits rolled off in the fall, there was a spike in labor force participation, but the gap between the number of job openings and the number of unemployed workers remained at all-time highs. For many reasons, including COVID worries, childcare issues, and early retirement, workers dropped out of the workforce and did not return. This shortage was already becoming an issue before the pandemic started. The number of jobs exceeded those looking for work even then. The pandemic only exacerbated the problem as seen here. There are currently 4.75 million more job openings in the U.S. than unemployed individuals looking for work.

Valuations 

The S&P 500 started 2022 only two hundred points away from 5,000, but with all the uncertainty around Omicron and then the Russian invasion of Ukraine, the index was down to just two hundred points above 4,000 by mid-March, representing a decline of approximately 13% from the early January record high. A lot of the pullback was led by growth sectors that did well coming out of the pandemic, while value-oriented sectors fared much better. Smaller capitalization stocks still fell in tandem with their larger counterparts though. Developed international and emerging markets also declined, seemingly in line with U.S. large-cap stocks. The path down wasn’t smooth - valuations were elevated entering 2022 and we had been expecting volatility since the second half of last year. 

The silver lining in this stock market correction is that valuations are now better. While earnings have been great, investors had been bidding up the price to buy into stocks and thus their future earnings streams. At year-end, the S&P 500 had a trailing price-to-earnings ratio of 25.2. This was in the 92nd percentile over the last 15-years and had only been higher 8% of the time. As of February 28, the S&P 500 P/E ratio was 21.3 and in the 88 percentile. Still high relative to recent history but closer to the 15-year average of 18.5. Valuations in midcap and small-cap are looking attractive from a historical perspective. These valuations are well below their average and in single-digit percentiles. You can see the fall in forward P/E ratios in this chart. These are based on the future 12-month earnings rather than the past 12 months we have been discussing. Regardless of what metric you prefer, valuations are getting better. International markets are also below their long-term averages.

Amongst the uncertainty, what we do know is that markets are resilient. In fact, history tells us that major geopolitical events tend to have a limited impact on markets after six to 12 months. So, sticking to your investment strategy may be the best approach. As quickly as markets fall, they can also go back up.

We are true believers in the resilience of the American economy. We also feel that the underlying strength of today’s economy still bodes well for overall growth. This doesn’t mean that we are passive. We are taking measured steps to rebalance portfolios where necessary and doing some tax-loss harvesting if appropriate.

In uncertain times, our highest priority is helping our clients keep emotions out of investing and ensuring that you remain focused on your long-term financial goals. We are on top of the situation and will continue to monitor events. Please do not hesitate to reach out to us with questions, concerns, or for some reassurance. We are here to support you and your family.