What Does the Ukraine Crisis Mean for Markets?
Investors should stay calm despite the conflict between Russia and Ukraine.
While tensions between Russia and Ukraine have been rising for years, the current military action is creating concerns about the potential impact on financial markets and the global economy. Fortunately, however, history shows that while geopolitical crises such as the one between Russia and Ukraine can temporarily roil markets, they don't typically have long-term consequences for investors.
As Dirk Hofschire of Fidelity's Asset Allocation Research Team says, "In general, these types of crises tend to only have a significant and lasting impact on global financial markets if they have a sustained macroeconomic impact on major economies." While Russia's economy ranks as the world's 11th largest, according to the International Monetary Fund, at only 1/20th the size of the US and 1/15th the size of China, it is likely not big enough by itself to affect global markets or economic growth, even if it were to suffer significant economic damage as a result of sanctions or other measures taken against it by the US and Europe.
Still, because Russia is also the source of 10% of the world's energy—and nearly 50% of the energy consumed in Europe—the conflict does pose risks that could extend beyond the 2 countries' borders including higher energy prices and increased financial market volatility.
What may happen in the short term
The severity of any potential market and economic disruption depends in part on what actions Russia takes. Fidelity's geopolitical risk analyst, David Bridges, says the conflict could take a variety of forms and continue for some time.
Another factor that would likely influence the impact of the situation on the economy and markets is how forcefully the US and Europe may respond with economic sanctions against Russia. Russia, in turn, could react to any sanctions against its financial interests by restricting its energy exports, particularly of natural gas to Europe.
Economic impacts
The impacts of the conflict are likely to vary depending on geography. Europe—and particularly countries such as the Baltic states and Poland—would be likely to experience more negative impacts than would countries that depend less on Russia for energy. Western Europe, particularly Germany, also has no easy alternative source of energy to replace Russian natural gas.
Hofschire says that an escalated Russia-Ukraine conflict would add uncertainty about the strength of the economic expansion in Europe. While that would inject some uncertainty into the global outlook, he says, the US economy would appear to be relatively insulated from the conflict. For individual investors and consumers in the US, the effects would most likely take the form of additional inflationary pressures due to higher energy prices.
Impact on markets
From an investment standpoint, the biggest impact will likely be negative market sentiment on Russian stocks, bonds, and currency. Hofschire says that a Russian military action against Ukraine also poses a relatively short-term risk to energy prices. "It could drive up prices of oil, natural gas, and other commodities at a time when inflation is already a problem." Higher oil and gas prices could further benefit North American energy companies, whose stocks have been among the best performers over the past year.
An increase in short-term stock market volatility is also likely. Says Hofschire, "A Russian military action likely adds to general market nervousness. Current stock market volatility is reflecting a variety of investor concerns, so another source of uncertainty and disruption won't help." However, Hofschire says additional inflation pressures and higher volatility by themselves won't cause a recession in the US.
Despite short-term geopolitical risks such as these, US investors should not lose sight of the long-term opportunities that international stocks may offer. Indeed, Hofschire's team expects international stocks to outperform US stocks over the next 20 years. Those expectations partly reflect the fact that US stocks have risen more than those of other countries over the past 2 years and US stock valuations are now high by historical standards.
Diversification and professional management can help manage short-term risks while pursuing long-term rewards. As Naveen Malwal, institutional portfolio manager with Fidelity's Strategic Advisers LLC, explains, "We hold stocks and bonds across many different regions, countries, sectors, and industries. One result of our diversified approach is that our clients generally have very little direct exposure to investments in Russia, and even less exposure to investments in Ukraine. That level of diversification can give investors some peace of mind in the face of geopolitical events." Or as Bridges puts it, "My view, as the old geopolitical guy, is to take the long view. Just stay focused and don't be afraid."