Keeping focused amidst rising geopolitical tensions

Market Volatility Intensified amid Major Escalation of Russia-Ukraine Crisis

US stocks fell on Wednesday as the Russia-Ukraine situation continued to escalate. The S&P 500 fell 1.8% and the Nasdaq Composite fell 2.6%, highlighting the weakness in the mega-cap/growth stocks.

Earlier this week, a series of sanctions against Russia were announced, as part of a coordinated response by the West. The sanctions announced so far do not disrupt existing exports of energy from Russia, and represent the first step taken to deter a further escalation of the Russia/Ukraine situation.

The UK chose to freeze the assets of five banks and imposed a travel ban on three Russian billionaires.  The EU sanction package was much tougher, including restrictive measures on 351 members of the State Duma of the Russian Federation, 27 individuals and entities who threaten Ukrainian territory and sovereignty, as well as targeting the ability of the Russian state and government to access the EU’s capital and financial markets and services. German Chancellor Olaf Scholz also announced that his country was halting the certification of the Russian Nord Stream 2 gas pipeline from Russia.

Finally, President Joe Biden announced a first tranche of US sanctions on Russia, targeting two state-owned banks which are supposedly closely aligned with the Kremlin. In addition, President Biden indicated that both banks would be banned from trading their debts in the US and EU markets and froze their assets under US jurisdiction. Some sanctions were also announced on key individuals. While some of the new sanctions have been criticized as being insufficient, President Biden noted that “if Russia goes further with this invasion, we stand prepared to go further as with sanctions”

Elevated Inflation Risk due to Energy Price Rise might also Limit Fed’s Desire to Turn Dovish

• German paused the certification process for Nord 2 pipeline, a 1200km gas pipeline from Russia into Germany, while Brent Crude approaching $100 per barrel. Rising geopolitical risk would increase inflation in energy, agriculture and materials. Meanwhile, falling growth expectations may hurt growth sectors in particular. US equities fell more than European ones and IT fell more than Industrials/Financials

• Weaker growth expectations and safe haven demand brought interest rates down. However, elevated levels of inflation may limit the Fed’s desire to react to the rising geopolitical risk and turn dovish. This is being reflected in financial markets with six rate hikes by the end of 2022 still being priced in. Citi analysts believe that the Fed’s policy path is likely to return as the main source of uncertainty

Geopolitical Shocks have Rarely Changed World Economic Trend

• As historical experience shows, when apprehension over geopolitical shocks has built up, it is very rare for negative market effects to last very long. Only 2 of 20 geopolitical shocks since WWII generated a true turning point for the world economy

• The most similar geopolitical event to Russia’s current presence on the Ukrainian border is Crimea in 2014. Oil peaked around the event, and there was no lasting impact on risky assets. The pattern surrounding the 2003 Iraq invasion was also similar, where oil went up into it, and down afterwards. The SPX recovered the sell off quickly and bonds gave back the early gains.

Keep calm and focus on the fundamentals

Citi analysts believe these are times to keep calm, assess if fundamentals have actually changed, and act on data and analysis, not fear. This is particularly true for long-term investment strategies.

• Contain fears: History shows that impact of local geopolitical shocks on risky assets is short-lived and does not change the long-term trend.

• Opportunities: Citi analysts expect more volatility in the near term, and investors should improve the quality of their asset allocation by adding exposure to high-quality assets including dividend growers, sectors with stronger returns and non-US developed markets large caps and China.