Russia invades

UKRAINE

The biggest mistake that an investor could make is to make extreme decisions during these uncertain times.

Jeff Powell | Managing Partner, CIO Tweet

The Russian invasion of Ukraine began with a fizzle, with Vladimir Putin ordering troops into separatist-held parts of eastern Ukraine under the guise of a “peacekeeping mission.” It was unknown how many Russian troops entered Ukraine after Russia “recognized” two pro-Russian breakaway regions, Donetsk People’s Republic (DPR) and Luhansk People’s Republic (LPR). This was followed by a full-scale invasion of Ukraine the very next day.

President Joe Biden imposed sanctions against Russia on Wednesday and followed up with further sanctions on Thursday in direct response to Russian aggression. The United States deployed its most powerful sanctioning tool, placing many of Russia’s elite and two banks on the Specially Designated Nationals list, effectively kicking them out of the U.S. banking system, banning them from trading with Americans and freezing their U.S. assets. Sanctions were also placed on Russian sovereign debt; essentially cutting off Western financing to the Russian government. The European Union and Britain announced similar plans, imposing the “harshest package of sanctions we have ever implemented,” as one top EU diplomat quoted. Germany froze their natural gas pipeline project with Russia.

Many investors fear the impact this invasion will have on the U.S. markets and economy. Fear of the unknown has been weighing on the U.S. stock market for the last week, as weeks of intense diplomatic negotiations seemed to have failed. Remarkably, the S&P 500 finished Thursday’s session up 1.50%, erasing a morning that had the broad-based markets down more than 2 percent. Even with this slight rally, the S&P 500 finished down 10.01% for the year. How should you navigate this geopolitical flareup? History is always a great place to help you make clinical decisions.

Most geopolitical events are nothing more than a blip on a generally upward moving graph. Many investors panic, selling
investments thinking that they are avoiding risk. The reality is that these types of events can be great opportunities to get cash working as these events quickly find themselves in the rear-view mirror. Let’s look at two studies to give you a proper perspective. 

The first study, found below, looked at thirty-three significant military occurrences which have occurred in the past century and how the Dow Jones Industrial Average traded in the subsequent trading days. As you can see from the study, the DJIA was up almost 70% of the time 13 weeks (approximately one quarter) after the military event occurred and rose an average of 3.1%. The numbers improve even more when looking out half a year (126 trading days is a little more than 25 weeks). Almost 85% of the time the markets had recovered, providing a 7.0% average return during that time. As the saying goes, “time heals all wounds.” 

We then looked at fifty-five crisis events that have occurred over the last hundred and fifteen years in the market. The crisis events created short-term losses of 7.1% during the “reaction dates,” a one would expect. As you can see from the study (included), these losses tend to be short-lived, with 81% of the time the markets recovered an average of 9.7%. The returns get even more impressive when looking out one year, with a 15.3% average appreciation from the reaction date ending.

Many investors overreact to military actions and crisis events, not realizing that these events tend to be short-lived. While there have certainly been significant pullbacks in the markets after some of these crisis events, typically these occurrences have coincided with historically negative economic events.

What Happens from Here?

We were not surprised to see Russia enter Ukraine today. You don’t move 190,000 troops to another country’s border, give a speech about the historical ties between your countries, without the possibility of larger intentions. The question is “does Russia have the stomach to launch a full-fledged invasion and occupation of Ukraine, or will they use it as a negotiating tool against the west?” Casualties for Russia will escalate. 

The optics of killing innocent Ukrainian civilians and potentially displacing millions would create a refugee crisis for central Europe. There will be a large monetary expense to invade and occupy Ukraine and additional economic costs felt through the sanctions imposed on Russia by the NATO nations. Further escalation could have a negative impact on the stock market, as fears that an armed conflict could spread to neighboring countries mounts.

What Else Can the U.S. Government Do?

Some call it the “nuclear option.” The United States could lobby to have Russia removed from SWIFT, the Society for Worldwide Interbank Financial Telecommunication. Over 11,000 financial institutions use SWIFT to send secure messages and payment orders. Removing Russia from SWIFT would make it nearly impossible for any Russian company to receive or make any financial transaction and would grind their economy to a standstill. The economic fallout could devastate Russia financially. The cutoff would terminate all international transactions, create extreme volatility to the Russian Ruble, and cause massive outflows of capital. 

President Biden has made it very clear that he is unwilling to put U.S. troops in harm’s way to defend Ukraine. That said, there are four NATO countries that border Ukraine, and another three other NATO countries, ex-Soviet Union states, that border Russia or Belarus. The United States has been sending additional troops to these countries to bolster their strength and to send a message of solidarity to Russia. Expect to see more U.S. troops sent to the area. We will be monitoring to see if Russia’s full-fledged invasion of Ukraine has any spill over to neighboring countries, most of which are NATO countries. If that happened (again, we feel that it is a low probability), the United States and other NATO countries would be forced to defend their allies.

What is Polaris Wealth Doing?

We are already in a defensive position. Our all-equity stock strategies are sitting with approximately 20% cash. Our balanced equity strategies are 15-20% underweighted to their benchmark equity allocation. If needed, we will get into a more defensive position by selling more stocks and moving further into cash. We are also looking at shifting our allocation into more defensive sectors in the market or areas we feel that will hold in or even thrive with this uncertainty.

The biggest mistake that an investor could make is to make extreme decisions during these uncertain times. As we’ve shown you in the studies provided, most armed conflicts are short-lived and have little to no impact on our markets. Obviously, every market acts differently. We will be vigilant in monitoring this situation to help us mitigate the risks to you and your portfolio.