Dear client,
There has been a lot that has transpired in the last two weeks, both on the geopolitical and economic fronts. If we didn’t know any better, we’d think there was no bottom to this market and everything was going to hell in a handbasket. Then we would be reminded to look at the facts.
Where are We Now? Trailing Returns Still Look Good
As of market close on March 9, 2022, the trailing return for various stock indices are still impressive:
What’s more, CNBC provides a helpful reminder that pullbacks in the range of what we’ve seen YTD are quite common. Or put another way, “When dividends are factored in, the S&P has risen 72% of the time year-over-year since 1926.”
No doubt, this year’s pullback is uncomfortable, especially for investors who got used to the standout returns of the past several years—the S&P 500, on a total return basis, rose 31.5% in 2019, 18.4% in 2020, and 28.7% in 2021. The interesting part is that the majority of the YTD pullback across markets took place before February 18th (which is the baseline for where we started to hear rumblings about an ever-increasing Ukraine/Russia conflict). From February 21st through market close March 9th, broad equity markets were down less than 2.5% while fixed income markets are in negative territory (with global bonds understandably selling off more than US bonds). Not bad, all things considered!
The price of oil has skyrocketed globally with its price exceeding $100/barrel. Does this go to $150 or $200? We do not know. The important point in our calculus is the duration that the price remains in that realm. If we get to the summertime and there are still prices in this range, you could definitely see the “R”(ecession) word rear it’s ugly head. Yet we must also remember that sustained oil prices do not automatically bring on recessions—brent crude was consistently (even persistently) above $100/barrel from circa spring 2011 to summer 2014, and the US still saw economic expansion and rising equity indices.
As of this writing, the United Arab Emirates and Iraq signaled that OPEC may be more open to raising production. We shall see, but markets responded with the price of oil dropping nearly 10% in a day. Additionally, this week we had President Biden announce the U.S. will no longer import oil from Russia. Below is a chart from GZero showing the percentage of crude oil that is imported by the U.S.
Where Do We Go From Here? Stay the Course
Our best advice with everything going on? Stay the course. We do not have any plans on making changes to our models given the current situation. If there is an opportunity you find you would like to take advantage of, we advise you to proceed with caution! We don’t foresee this conflict wrapping up within the next several days—in fact, we think this could drag on for months or even years (remember the USSR’s invasion of Afghanistan?)—and so in the short term we expect more volatility. That said, we do believe that markets will recover, and that the Ukraine/Russia conflict will slow—but not completely derail—global economic growth and corporate profits. We are thus comfortable with the amount of risk we currently have in our portfolios.
What Would Cause Us to Reconsider? The Ever-Elusive Next “Black Swan”
Finally, having such geopolitical crises take place has us reevaluating what type of events would need to take place for there to be a dramatic change in our investment outlook and portfolio positions. Below we’ve included just a handful, all of which we believe to be low probability events:
Escalation Events (Black Swans)
1. Material escalation from Putin on the war front—using nuclear weapons, EMPs, chemical or biological weapons, or invading a NATO or EU country
2. Oil prices remain above $100/barrel for an extended period of time—HOWEVER, brent crude was >$100/barrel from spring 2011 to summer 2014 but we still had positive (albeit low) economic growth
3. Stagflation (slowing growth or economic contraction + rising inflation)—not our base case, but the Fed might fail to get inflation under control, or tighten the US economy into a recession
4. Emergence of a COVID variant that is more deadly and infectious than prior variants—this would be quite the black swan considering the typical path of a virus is to mutate towards higher virality and = lower mortality, as we saw with the progression from delta to omicron
5. Any invasion of China into Taiwan, although in our belief unlikely, would have dire economic consequences for many
Thanks for your trust in Anfield. Please let us know what questions you may have and we are happy to help.
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