Strategic Income Outlook: War is Hell

As yet, 2022 has not been kind to investors. There are many crosscurrents and much uncertainty, and the war in Ukraine has thrown a wrench in the world’s economic spokes. Inflation was already rising, but now prices for oil, natural gas, wheat, and metals have soared. With this backdrop, the Fed, along with a few other central banks, has begun raising interest rates to combat inflation – better late than never. As a result, the amount of negative-yielding bonds around the world has declined markedly. Additionally, the U.S. yield curve has now inverted, giving rise to fears about an impending recession, or at best, stagflation. There seem to be more questions than answers now as we try to make rational choices about how to navigate through this volatile period.

The Russian invasion of Ukraine has changed the narrative for the markets. Seemingly overnight this humanitarian crisis has galvanized Europe and the West into action. Clearly, the goal is to resolve the conflict without igniting a third world war. While no one knows how this will end, the equity markets initially sold off sharply but have since recovered. Sadly, except for some (hopefully temporal) commodity supply dislocation this is less of an economic event than a geopolitical one. Russia and Ukraine are not economic powerhouses save for the export of some commodities, specifically oil, natural gas, wheat, and some metals, including nickel, all of which saw huge price spikes following the invasion. Volatility in commodity prices has calmed down a bit, although they still are quite elevated versus prewar levels. We would expect supplies from elsewhere to increase over time and for prices to ease. As the adage in commodity markets goes, the cure for high prices is high prices!

Luckily, the U.S. economy was in robust health before the Fed started operating on it, but a war and higher inflation make it trickier to navigate the Fed’s preferred path of a gradual interest rate normalization. As we said in a recent missive, the outbreak of war has not always meant a bear market for stocks. In fact, looking at 21 past geopolitical events, beginning with the attack on Pearl Harbor in 1941, the average number of calendar days to find a bottom was 22 and the average number of calendar days to recovery was 47. Russia invaded Ukraine on February 24th. The market hit its lowest point to date on March 8th and closed above its prewar level on March 16th. Luckily, thus far history seems to be repeating!