We recognize the Russian invasion of the Ukraine,  together with their nuclear sabre-rattling, has everybody a bit on edge. As expected volatility in the stock market continued into February, with investors whip sawed by good economic news vs. rising inflation and fears of Federal Reserve interest rate increases, coming to a head with the unprovoked invasion of the Ukraine by Russia on February 24th.

As trading began the following day, stocks collapsed, dropping the S&P500 -14%, and the NASDAQ composite index -22% from their peak values. This constitutes deep correction levels. Then a huge influx of buyers swooped up technology and growth stocks,  unleashing a complete reversal and a huge relief rally, narrowing the losses for the year-to-date to -8.22% for the S&P 500 and -12.10% for the NASDAQ.

Russia's invasion of the Ukraine is the start of the largest land war in Europe since Hitler invaded Poland to start World War II. Stay prepared for lots more stock market volatility. Russian President Putin ordered the offensive with the aim of toppling Ukraine's government and regaining control of the country...and ultimately perhaps other former satellites of the Union of Soviet Socialist Republics. He confirmed what many suspected, namely that he is a KGB thug, indifferent to human suffering and the well being of his own citizens. 

Western powers and their allies had certainly been forewarned. As far back as 15 years ago President Putin then railed against US domination of global affairs and saying he considers NATO a threat to his country.  His annexation in 2014 of parts of Georgia and the Crimea, and fomenting unrest in Eastern Ukraine, has unfortunately produced no real consequences from us here in the West. Bullies will thus be emboldened.

At least now the US and its European allies have started to impose  severe economic sanctions. Russia is being made to suffer - the Russian ruble cratered to less than 1 US cent, and its stock market froze after  Russia's removal from global banking system. Companies worldwide are starting an unofficial boycott by not purchasing/importing Russian products, and Apple, e.g. is refusing to sell product in Russia. These economic steps cannot be underestimated, and we believe at a certain point, the Russian people may become unhappy with Putin’s ill-thought out adventure that is turning Russia somewhat into  a rogue state. In an interconnected, inter-dependent world, being frozen out economically can be a powerful stick. Further, there is  some  evidence emerging that the much-vaunted Russian military advance (the “40-mile convoy”) is having trouble with supplies and morale.

We aren’t naïve to think Ukraine can resist the invasion for long, but there is some chance of a stall and re-think. We certainly hope so for the Ukrainian people, as well as the fact that the long term global economic impacts resulting from the Russian action, especially on commodity prices, probably mean higher inflation and slower growth. Russia produces 10% of all the world's oil. Together with Ukraine they produce 25% of all wheat and 30% of all palladium, and most of the the neon gas used in semiconductor production. 

While it is a leap to suggest we are on the verge of a new Cold War, it is reasonable to expect the following in the coming years:

A)  After decades of flat military spending at roughly 2.4% of global GDP, many countries will react to the Russian action by thoughtfully increasing their defensive capabilities.

B)   Less globalization. The enormous dependence of almost every supply chain on Chinese sources, and Europe’s insane 40% dependence on Russia for its natural gas, will require a multi-year effort by the Western world to break this reliance on unpredictable autocrats!

C)  Future geopolitical tensions. It is conceivable that countries with powerful and ruthless neighbors (Russia and China) will see Ukraine's fate as a reason to secure nuclear weapons. Taiwan cannot be feeling secure these days. Even countries under US protection, such as Japan and South Korea, might reasonably worry about the reliability of their ally and want nuclear deterrence themselves.

In spite of the preceding concerns, a review of the most recent economic indicators confirms slower but robust economic growth in 2022, subject to the pace and magnitude of Fed rate increases, and any unexpected turns in the economy and geopolitical scene.

1. Inflation. The January increase in the consumer price index to 7.5% was the highest since 1982! This reinforces the need for the Fed to start the inflation battle by a) raising rates and b) withdrawing excess money supply to decrease consumer demand (“Quantitative Tightening”). We believe the Fed will act faster than previously thought. But it will be a tough battle to pull back the largesse of the multiple post-pandemic relief packages  which continued long after the economy had begun to heal, a big mistake in our view  – all-too easy money created consumer demand at a time when supply was disrupted by Covid, and  that’s why we have such bad supply chain problems, which the Fed cannot control.

2. GDP. The 2nd reading of 4th quarter GDP was raised to 7% notwithstanding the severe Omicron impact on consumer spending in December. The virus's full impact may be felt in lower 1st quarter 2022 GDP, possibly around 2%. But similarly following the slowdown in the 3rd quarter of last year, higher growth is then expected in the 2nd quarter of this year.

3. Unemployment claims. As the impact of the Omicron variant started falling rapidly in the past 4 weeks, so did weekly unemployment claims, with the 3 week average down to 232,000 from the prior 260,000. With a January unemployment rate of 4%. It is essential that more people currently on the sideline start actively looking for work in the months ahead - a higher labor participation rate is the best way to contain the runaway inflation in wages.

4.  Miscellaneous indicators. Other than a small decrease of -0.3% in the LEI (leading economic indicators) in January, most indicators improved slightly in January. Retail sales jumped 3.8% exceeding all expectations and could be signaling economic strength (though the price of gasoline has surged 40%, ouch!). The tail end of 4th quarter 2021 earnings with 417 companies in the S&P reporting earnings and revenue to date, almost 80% reported above expectations, compared to long term averages of about 65%.  These are outstanding results!!

Additionally, we like these facts:

• The  Yield Curve is still positive/not inverted, often a harbinger of Recession,
• Borrowing is still relatively cheap,
• Banks passed their stress tests well above their required capital levels,
• The overall direction of the leading indicators is still positive.

The uncertainties introduced by Russia's invasion, plus any changes in interest rates, will become clearer by March 16 after the Fed next meets. We do expect the erratic market action to start subsiding as we move into the 2nd half of 2022, subject of course to a resolution of the current Ukrainian conflict and no major increase in inflation from current levels.  During this volatile time we continue to recommend remaining fully invested for your appropriate asset allocation and not making abrupt decisions, if possible.  Long term the economics always prevail over geopolitical unrest.

• Data from Wall St Journal North American Edition and Yahoo Finance, believed reliable but not guaranteed.